Bank of America derivatives transfer is criticized by Democrats in Congress

CharlotteObserver.com Business
October 28, 2011
Bank of America derivatives transfer is criticized by Democrats in Congress

Lawmakers are criticizing Bank of America Corp. again, this time over the reported transfer of financial instruments from Merrill Lynch into the bank's deposit-taking arm.

It's a move the lawmakers say could put taxpayers on the hook for big losses - three years after the bank received billions in bailouts from the federal government.

More than a dozen Democratic members of Congress, including U.S. Rep. Brad Miller of North Carolina, wrote to federal regulators Thursday, asking why they allowed the move of derivatives into the retail bank, which contains deposits insured by the Federal Deposit Insurance Corp.

"This kind of transaction raises many issues of obvious public concern," Miller said in a statement. "If the bank subsidiary failed, innocent taxpayers could end up paying off exotic derivatives."

Bank of America spokesman Jerry Dubrowski said the bank's derivatives trades are subject to risk-management controls and are client-driven, not proprietary trades - meaning the bank is not betting with its own money.

"Bank of America serves clients' needs, including with cash and derivatives instruments, through many of its affiliates, including the bank," he said. "This is permissible in the current regulatory environment, and it is not expected to significantly change with the implementation of Dodd-Frank."

The retail subsidiaries of some other big U.S. banks, including JPMorgan Chase & Co. and Citigroup Inc., have as much or more in derivatives as Bank of America, data show.

Bank of America transferred the derivatives from Merrill Lynch after a credit downgrade in September, moving the contracts to the retail bank, which has a higher credit rating, Bloomberg News reported last week.

According to the Bloomberg report, the Federal Reserve favored moving the derivatives to give relief to the bank holding company, while the FDIC - which has to pay off depositors if a bank doesn't have the money to make them whole - objected.

Fed spokeswoman Barbara Hagenbaugh on Wednesday declined to discuss "supervisory matters pertaining to individual institutions." FDIC spokesman David Barr also declined to comment.

The lawmakers' letters represent politicians' latest barb at the nation's second-largest bank. It has repaid the federal government, but now has caught flak over its lingering mortgage woes and, more recently, the $5 monthly fees it will begin charging some customers who make purchases with their debit cards.

Earlier this month, U.S. Sen. Dick Durbin, D-Ill., railed against Bank of America and encouraged customers to switch banks.

And Miller introduced a bill aimed at making it easier to leave big banks, saying they "act like they have monopoly power."

UNC Charlotte finance professor Tony Plath said there's some validity to the congressmen's concern that Bank of America's derivatives transfer might violate a section of the Federal Reserve Act that limits transactions between the bank and nonbank affiliates to avoid subsidizing risky transactions with deposit insurance.

"That's one of the firewalls the Federal Reserve has," he said. "That in turn prohibits the banking unit ... from becoming excessively risky."

Derivatives themselves are not FDIC-insured, meaning taxpayers would never be on the hook directly for their repayment, Plath said. But derivatives used in connection with the bank's trading operation that are held by counterparty creditors have priority if the bank is unable to pay its debt, he said.

That means there are circumstances where the bank could repay derivatives losses with money that would otherwise be used to cover taxpayer-insured deposits, Plath said.

He said he would think the bank sought approval from the Fed before it transferred the derivatives. But he wondered why, in that case, the regulator didn't come out and explain why it permitted the move.

In the letters to regulators, lawmakers urged the agencies to stop treating the transaction as a private matter.

They posed a series of questions, including whether the derivatives pose a risk.

Said U.S. Sen. Sherrod Brown, D-Ohio: "At a time when systemically important banks are increasing their capital relative to their credit risk, these transfers are having the effect of increasing Bank of America, N.A.'s credit risk relative to capital."

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