Thanks to an outpouring of complaints and a reversal of similar plans by major competitors, Bank of America finally canceled its plan to start charging customers a $5 fee to use their debit cards for purchases. The plan had particularly rankled those who contend that it had nothing to do with covering legitimate expenses and everything to do with covering bad bets that the bank has made in other areas. (The amount the bank charges merchants for its service is about three times what it actually costs to process a transaction.)
Several other recent BoA decisions have also generated anger. In May, the bank raised its checking account fees, which include e-banking, by 34%, and in June it initiated a $35 overdraft fee on overdrafts of a penny or more. Next year, it will trot out a new "essentials" checking account structure that tacks on yet more mandatory fees.
Some activists have been urging depositors to respond by pulling their money out of BoA, and a few politicians have chimed in. "Vote with your feet. Get the heck out of that bank," says Senator Dick Durbin (D-IL).
People who leave their money with BoA already know (or should) that they're taking a fair-sized risk. In late September, Moody's dropped the credit rating of the bank's long-term holding company two levels, from A2 to Baa1, and cut its retail bank rating from A2 to Aa3. There are over $1 trillion in deposits still in an institution sitting on a status that is barely north of junk.
"Bank of America is the only US lender that lacks a rating of A3 or higher among the five firms listed by the Office of the Comptroller of the Currency as having the biggest derivatives books," Bloomberg wrote in an October 18 story.
Behind the word "biggest" lies a reality that is truly mind boggling. Bank of America's holding company - the parent of both the retail bank and the Merrill Lynch securities unit - held almost $75 trillion of derivatives at the end of June, according to data compiled by the OCC. That's trillion, with a T.
And here's the really cool part. Can you guess who's on the hook if that gargantuan derivatives book blows up in BoA's face?
A lot of that potentially toxic waste used to be over in the Merrill division, but that wasn't so good, because investments there have no federal backing. And with the bank's near-junk status laid bare by the Moody's downgrade, it "spurred some of Merrill's partners to ask that contracts be moved to the retail unit, which has a higher credit rating, according to people familiar with the transactions," Bloomberg wrote. "Transferring derivatives also can help the parent company minimize the collateral it must post on contracts and the potential costs to terminate trades after Moody's decision, said a person familiar with the matter. "
Do you get what's going on here? The retail unit has the FDIC as a backstop (paid for with our money); Merrill doesn't. So BoA shifted who-knows-what-kind of toxic paper from one division to another, et voilà! Instant respectability. And, "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," wrote Rep. Brad Miller (D-NC), one of eight House members who signed a letter to Secretary of the Treasury Tim Geithner.
Instead of the FDIC doing its regular job of protecting mom and pop, it's been forced to open an ATM at the big casino. As Rep. Maurice Hinchey (D-NY) put it, "This is the opposite of capitalism - the risks are socialized and the benefits are privatized."
"Forced" is the operative term. Bloomberg again:
The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said [people with direct knowledge of the situation], who asked to remain anonymous because they weren't authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting.
FDIC vs. the Fed? No contest there.
Now, the Fed - according to Bloomberg - has the power to limit these kinds of transfers "under Section 23A of the Federal Reserve Act, which is designed to prevent a lender's affiliates from benefiting from its federal subsidy and to protect the bank from excessive risk originating at the non-bank affiliate."
However, it also has the power to grant exemptions to 23A. Whether BoA specifically asked for Fed permission before making its recent moves is unclear, as none of the parties involved is saying much. But it probably didn't have to. The bank received such an exemption in September of 2010 and can be forgiven if it feels it's been granted an implicit guarantee that it is too big to fail.
"As a general rule, as long as transactions involve high-quality assets and don't exceed certain quantitative limitations, they should be allowed under the Federal Reserve Act," Bloomberg wrote, quoting Saule T. Omarova, a law professor at the University of North Carolina at Chapel Hill School of Law.
High-quality assets? Hmmm...
Though it's probably all perfectly legal, that hasn't stopped some lawmakers from stepping in. In addition to the abovementioned Miller's letter, a similar one has emerged from the Senate.
"This provides an additional safety net subsidy for one of the biggest derivatives dealers that is contrary to ... the original intent of the Federal Reserve Act and the Federal Deposit Insurance Act," 10 senators wrote in a letter to Fed Chairman Bernanke, Acting FDIC Chairman Martin J. Gruenberg, and Acting Comptroller of the Currency John Walsh.
Of course, it's always possible that BoA's derivatives basket is full of Grade A stuff and that no bad will come of this.
But experience suggests that, while we should hope for that outcome, we should also prepare for the next big bailout.