BofA shifts derivative risk. Evil, good or neither? Discuss.

by Karoli on October 22, 2011 · 206 comments

This started on Twitter as a discussion1 between @rootless_e and myself over this post. Then this one by Mike Lux went up a few minutes ago. Rootless observed that the first post was not complete in how the scenario plays out. The second post leaves room to wonder.

DesertBeacon wrote on this a few days ago in the context of financialization, and how it’s stifling the economy, simply because we’re shifting from a market economy to a financial economy.

Perhaps now the average American victim of the credit meltdown, whose tax dollars were used to guarantee the solvency of the American bankers, are tired of being scapegoats?  Members of the financial sector, whose avarice engendered the over-heated housing bubble, cry “Irresponsible Borrowers, Mortgage Twins, Community Reinvestment Act” in a manner analogous to the practice of putting one’s fingers in one’s ears and repeating “La, La, La, La I Can’t Hear You.”  {stage directions: “door slams, sound of car leaving driveway}

“Mother said you were shiftless.”  There’s nothing a disreputable person loves more than to remain unsupervised.   Likewise, there is nothing an ethically challenged group loves more than deregulation.   Why else would banks revise their charters to place themselves under the eyes of those government agencies most willing to look the other way?  [DB] [NRP] [TBS] And yet the banking corporations and their supporters continue to prescribe deregulation as the way to protect American taxpayers, account holders, and consumers.

Before Congressional investigators the Wall Street barons proclaimed their patriotism and devotion to American “ethics and values,” back in their corporate offices they reinforced the notion that any “market” was ethical as long as there were two willing partners to the transaction — even if one was being sold a pig in a poke — even if the investment bank was betting against its own deal. [Bloomberg] [NYT]   Brooksley Born, former head of the CFTC tried to warn us about the deregulation of credit default swaps before most people had even heard the term, she was rewarded for her prescience by being replaced, and later labeled a Cassandra. [WaPo] [PBS] {stage directions:  two adversaries sit in tense silence across the room…}

“How can you keep running up these bills?”  Corollary to ” You promised you’d stop…“  If we were thinking that the popularity of credit default swaps might have declined in the wake of the housing bubble collapse, consider their use as European economies struggle.  [Bloomberg] As for the infamous CDO’s — some settlements have been agreed upon, but Morgan Stanley was exonerated from charges of defrauding a government pension fund (Libertas Case) because the offerers, not Morgan Stanley, prepared the statements. [Reuters] {stage directions: A throws pile of paperwork at B}

“You expect everyone else to clean up your messes.”  One such mess is “financialism.”

“Over the last 25 years American capitalism has become financialism, which is primarily transactional, unrestrained greed. Financialism embraces the view that the only purpose of business is to create shareholder value, measured primarily by short-term results. The dominance of short-termism is evidenced by the magnitude of institutional stock “renting” for terms of 12 months or less, the volume of high-speed, high-frequency algorithmic short-term trading, the short average tenures of chief executive officers and the dominance of executive compensation tied solely to short-term results.”  [Forbes]

And, this is a truly large mess, something Adam Smith never contemplated. Financialism distorts capitalism and creates middle class income stagnation, income disparity, off shoring jobs, diminished manufacturing capability, and equity market volatility.   It is the financial equivalent of being “excused” for leaving dirty clothing, empty pizza boxes, half-empty pop cans, and dirty tableware scattered about because “I’m busy.”  It is to trade short term profitability for long term stability.   If it’s messy, so be it, the “taxpayers” will clean up after us.   {stage directions: clothing, pizza boxes, pop cans hurled against wall to make a pile on the floor}

Rootless contends that by shifting the toxic securities into a FDIC-insured entity, the FDIC can simply shed them (toss in the trash) without harming taxpayers.

Here are my questions:

  1. Who are the depositors in this FDIC-insured institution? In other words, whose deposits are being insured?
  2. Is there a moral hazard issue here inasmuch as BofA was able to shift those liabilities off their books without penalty, enabling them to declare a $6 billion profit for the third quarter?
  3. How does any financial institution accrue risk of $75 trillion in imaginary money without some penalty?

For background on financialization, I recommend these posts and their contained links:
Oh, Brother Can You Spare A CDS? Financialism Erodes Free Market Capitalism

For The Love Of Money: Financialists vs. Capitalism

Hopefully some answers will emerge in the comments. Feel free to discuss. I’ll be there.

Also, this discussion of the term “notional” is a critical one to understand the underlying issues.

1 Chirpstory of our discussion:

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