Bloomberg News

Bank of America Derivatives Transfer Draws Lawmaker Scrutiny

November 01, 2011

(Updates with additional Bank of America response starting in seventh paragraph.)

Oct. 27 (Bloomberg) -- Congressional Democrats are asking regulators whether they explored possible risks connected to Bank of America Corp.’s moving of derivatives from Merrill Lynch into its deposit-taking unit after a credit downgrade.

Eighteen lawmakers signed onto letters from Representative Brad Miller and Senator Sherrod Brown seeking information about whether agencies consulted on the transfer considered the potential impact on the bank’s health and customer accounts.

“Because of the favored treatment of derivative contracts in receivership, it appears highly likely that losses on derivatives would result in losses to insured deposits ultimately borne by taxpayers,” Miller wrote in his letter, which was signed by eight House Democrats. The transfers were first reported by Bloomberg News on Oct. 18.

Democratic lawmakers, many of whom sought Dodd-Frank Act amendments to wall off banks’ customer deposits from risky businesses such as derivatives trading, are pressing the Financial Stability Oversight Council for information on its role and oversight of the transaction.

Bank of America, based in Charlotte, North Carolina, transferred derivatives after a September downgrade by Moody’s Investors Service spurred some partners of the bank’s Merrill Lynch brokerage unit to ask that contracts be moved to the higher-rated retail bank, according to people familiar with the transactions.

Bank of America Response

“Bank of America serves clients’ needs, including with cash and derivatives instruments, through many of its affiliates, including the bank,” Jerry Dubrowski, a Bank of America spokesman, said today in an e-mail. “This is permissible in the current regulatory environment, and it is not expected to significantly change with the implementation of Dodd-Frank.”

Bank of America doesn’t hold derivatives in its deposit-taking arm to the degree that major competitors do, said Dubrowski. The firm held about $53 trillion, or 71 percent of the company’s total derivatives, in a deposit unit as of June 30, according to data compiled by the Comptroller of the Currency. That compares with a JPMorgan Chase & Co. deposit- taking entity, which contained 99 percent of the New York-based firm’s $79 trillion of notional derivatives.

Moving derivatives contracts between units of a bank holding company is restricted under Section 23A of the Federal Reserve Act, which is designed to keep lenders’ affiliates from benefiting from federal subsidies and protect banks from excessive risk originating at non-bank affiliates.

Geithner

Miller’s letter, which was sent to Treasury Secretary Timothy F. Geithner and members of the oversight council, asks regulators about the quality of the transferred portfolio, as well as a price for the derivatives book if it was considered by the Fed to be an asset purchase. It also asks whether Bank of America made proprietary risk models available to regulators and whether there was exposure to Europe’s debt crisis.

Brown’s letter, dated today and signed by 10 senators including Carl Levin, the Michigan lawmaker who leads the Permanent Subcommittee on Investigations, sought similar information and questioned whether the Fed explicitly granted an exemption and whether the transfer was legal.

‘Additional Subsidy’

“This provides an additional safety net subsidy for one of the biggest derivatives dealers that is contrary to not only the principles, and potentially the strictures, of the Dodd-Frank Act, but also the original intent of the Federal Reserve Act and the Federal Deposit Insurance Act,” Brown wrote in the letter to Fed Chairman Ben S. Bernanke, Acting Federal Deposit Insurance Corp. Chairman Martin J. Gruenberg and Acting Comptroller of the Currency John Walsh.

Andrew Gray, a spokesman for the FDIC, declined to comment on the letters. Barbara Hagenbaugh, a spokeswoman for the Fed, said in an e-mail that the central bank had received the letters and would respond. Dean DeBuck, a spokesman for the OCC, didn’t have immediate comment on the letters.

Separating complex transactions from FDIC-insured savings has been a cornerstone of U.S. regulation for decades, including Dodd-Frank, the regulatory overhaul enacted last year. Bank of America’s transfer prompted some lawmakers to push for stronger rules than were included in that sweeping law.

Senator Bernie Sanders, a Vermont Independent who supported legislation to separate trading operations from commercial banking, said the transaction is a “perfect example why we should break up too-big-to-fail financial behemoths.”

‘Outrageous’

“If federal regulators give the green light to Bank of America to move its risky derivative schemes it acquired from Merrill Lynch into its federally insured commercial banking subsidiary that would be outrageous,” Sanders said.

Representative Maurice Hinchey, a New York Democrat who pushed to require splitting commercial and investment banking, said Bank of America’s actions underline a lost opportunity.

“What Bank of America is doing is perfectly legal -- and that’s the problem,” Hinchey said.

Hinchey is among more than 40 House lawmakers who have signed on to a bill that would reinstate the Glass-Steagall Act, the Depression-era law that enforced separation of depository institutions from investment operations before it was partially repealed in 1999.

“The FDIC is in effect being forced to insure Wall Street’s risk-taking,” Hinchey said in a statement. “This is the opposite of capitalism -- the risks are socialized and the benefits are privatized.”

Senators John McCain, an Arizona Republican, and Maria Cantwell, a Washington Democrat, lobbied last year for a Senate floor vote to reinstate Glass-Steagall. The amendment never got a vote. Cantwell was among the senators signing Brown’s letter.

--With assistance from Hugh Son, Donal Griffin and Christine Harper in New York and Meera Louis in Washington. Editors: Maura Reynolds, David Scheer

To contact the reporters on this story: Phil Mattingly in Washington at pmattingly@bloomberg.net; Bob Ivry in New York at bivry@bloomberg.net

To contact the editors responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net; David Scheer at dscheer@bloomberg.net


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