Tag Archives: Bank of America

The Bad Old Days

By James Kwak

There was a time when the main purpose of this blog was to explain just how some government policy or other official action was designed to benefit some large bank under the cover of the public interest. In a bit of nostalgia, I wrote this week’s Atlantic column on the Freddie Mac–Bank of America story reported on by Gretchen Morgenson. It’s clear that Bank of America got a sweetheart deal from Freddie. The question is why. Did Freddie Mac’s people, some of the most knowledgeable people in the country when it comes to mortgages, not realize they were giving away money? (Hint: Probably not.) Did FHFA examiners, some more of the most knowledgeable people in the country when it comes to mortgages, not realize that Freddie was giving money away? (Hint: See above.)

It’s amazing that after three full years of our government trying to give Bank of America money at every possible opportunity, it’s still a basket case. Now it’s charging people $5 per month to use their debit cards. Yes, this is a predictable response to new Federal Reserve regulations limiting debit card fees. But it’s easily avoidable: just find another bank. (Neither of mine charges me debit card fees.) Not every bank out there is still trying to pay for the Countrywide acquisition.

Three Questions For The Financial Stability Oversight Council

By Simon Johnson

The Dodd-Frank financial reform legislation of 2010 created a Financial Stability Oversight Council (FSOC), with the task of taking an integrated view of risks in and around the U.S. financial sector.  The FSOC is comprised of all leading regulators and other responsible officials, chaired by the Treasury Secretary.  So far, it has done little – fitting with the predominant official view being that in the post-crisis recovery phase, financial risks in the U.S. were generally receding rather than building up.

But this summer has established three important and related issues on which FSOC needs rule quickly.  These are: impending bank mergers that could create two more “too big to fail” banks; whether to force the break-up of Bank of America; and how to rethink capital requirements for large systemically important banks, particularly as the continuing European sovereign debt problems undermine the credibility of the international Basel Committee approach to bank capital. Continue reading

Dividend Lost

By Simon Johnson

Four types of people were directly affected by the Federal Reserve’s decision at the end of last week to allow major banks to increase their dividends and to buy back shares.  Three of these groups – bankers, bank shareholders, and government officials – were somewhere between happy and delighted.  The four group, US taxpayers, should be much more worried (see also this cautionary letter to the Financial Times by top finance academics).

The bankers’ reaction is obvious.  They are officially released from the financial hospital ward that was set up for them in 2008.  No matter that this was a very comfortable place with few conditions relative to any other bailout in recent US or world history – there were still restrictions on what banks could do and, naturally, bank executives chafed at these constraints.

In particular, banks were required to build up the equity in their business – insolvency is avoided, after all, while there is positive equity in a business.  When shareholder equity is exhausted, creditors face losses. Continue reading

“We Have Good Processes and Good Controls”

By James Kwak

One of the things I can’t stand about the corporate world is the tendency of senior executives to say things that they wish were true, without verifying whether they actually are true or not. Perhaps my favorite example of all time is Stan O’Neal’s internal memo from mid-2007:

“More than anything else, the quarter reflected the benefits of a simple but critical fact: we go about managing risk and market activity every day at this company. It’s what our clients pay us to do, and as you all know, we’re pretty good at it.”

But here’s another good one from Barbara Desoer, head of Bank of America’s home loan division (to Bloomberg):

“We believe that our assessment shows the basis for past foreclosure decisions is accurate. We have good processes and good controls.”

And apparently she’s sticking with this line. This week she told Congress, “Thus far we have confirmed the basis for our foreclosure decisions has been accurate.”

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Are Regulators Trying to Make Bank of America Smaller?

By James Kwak

Last week, Charlie Gasparino reported at Fox Business that “Executives at Bank of America are coming under increasing pressure to downsize the firm as federal regulators seek to prevent large, cumbersome financial institutions from once again tanking the financial system as they did in the fall of 2008.” Later, he writes, “people close to the bank and government officials say government regulators have made it clear to BofA executives, including its new CEO, Brian Moynihan, that they want the bank to become much smaller.” The article refers to officials at Treasury and the Federal Reserve.

This would be interesting for a couple of reasons. One is that the administration and its allies in Congress are insisting that breaking up large financial institutions is not the answer to the too big to fail problem. If regulators are pressuring BofA to get smaller, that would seem to imply the opposite.

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Good for Bank of America

I think. BofA is eliminating overdraft protection on debit card purchases. Most stories, like in the Times and the Journal, are headlining the elimination of overdraft fees, but it’s not like you’re getting overdrafts for free; actually they are eliminating overdrafts on debit card transactions altogether, starting this summer. (You will still be able to opt in to overdraft protection for debit card transactions, but only if you link your checking account to another account, so the money is being transferred from yourself. You will also be able to opt in to overdraft protection, with fees, for checks and automatic bill payments;* and you will be able to decide on the spot if you want to pay a fee to overdraw your account from an ATM.)

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Bye-Bye, Bank of America

As I was waiting for the very nice bank teller to give me my bank check for the balance in my account, the woman next to me was trying to tell her very nice teller that she did not want overdraft protection on her account. She was told she would have to wait fifteen minutes to talk to a “personal banker” to remove it. Weren’t big banks supposed to be more efficient?

My nice “personal banker” made the mistake of asking me why I was closing my account. So I told him:

  • One of my local banks refunds my ATM fees at other banks.
  • My other local bank pays 0.75% interest–on an ordinary checking account.
  • Bank of America breaks the law.
  • Bank of America closed two out of the three branches in my town.
  • Oh, and it’s too big, and presents a systemic risk to the U.S. economy.

Behind him was a sign encouraging people to use their debit cards to pay for purchases to take advantage of a “savings” program that moves what is already your own money from your checking account to your savings account.

Afterward I went out for a martini even though it was just before noon. Yes, changing your bank account is a hassle. But the satisfaction is worth it.

By James Kwak

Why Did Bank of America Pay Back the Money?

Everybody knows by now that Bank of America is buying back the $45 billion of preferred stock that the government currently owns. While the reason why they are doing this is obvious, I’m going to pretend it isn’t for a few paragraphs.

Buying back stock costs money — real cash money. Why would a company ever do such a thing? The textbook answer is that a company should do it if it doesn’t have investment opportunities that yield more than its cost of capital. The cash in its bank account, in some sense, belongs to its shareholders, who expect a certain return. If the bank can’t earn that return with the cash, it should return it to the shareholders. In this case, though, the interest rate on the preferred shares is only 5%, which is far lower than usual cost of equity. In fact, Bank of America just issued $19 billion of new stock in order to help buy back the government’s preferred stock. The cost of that new equity (in corporate finance terms) is certainly higher than 5%. In other words, Bank of America just threw money away.

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Accounting at B of A and Fannie

Via Yves Smith, John Hempton analyzes the quarterly results of Bank of America (so-so) and Fannie Mae (terrible). The underlying issue is that bank quarter-to-quarter results are largely driven by the amount of provisions they take against future loan losses. You can think of this as a very rough approximation to marking-to-market — instead of waiting for the loans to default, you estimate how many loans will default in the future (that estimate should change as the economic situation changes) and put that amount of money into reserves. Then when the defaults actually happen, you take the money out of reserves.

Hempton argues that Bank of America and Fannie Mae are estimating extremely different future loan losses, and those differences cannot be attributed to differences in their current performance (the rate at which loans are defaulting now). If I wanted to be provocative I would only show you this quote:

If Bank of America were to provide at the same rate its quarterly losses would be 50-80 billion and it would be completely bereft of capital – it would be totally cactus. It would be – like Fannie Mae – a zombie government property.” [emphasis in original]

(“Totally cactus” — I like that.)

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More on Bank of America

Last Wednesday I wrote a highly critical post about the agreement between Bank of America(BAC)  and the government (Treasury, the Fed, and the FDIC) to terminate BAC’s asset guarantee agreement in exchange for a payment of $425 million. I’ve learned some more about this and I think I can reconstruct the government’s perspective on this issue, with the help of someone knowledgeable about the transaction.

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Bank of America $4 Billion, Taxpayers $425 Million

I’m trying to figure out if I should be infuriated about the agreement allowing Bank of America to walk away from the asset guarantees it got as part of its January bailout in exchange for a payment of $425 million. I can piece together part of the story from The New York Times, Bloomberg, and NPR, but the complete story is a bit hazy.

The initial deal was that Treasury, the FDIC, and the Fed would guarantee losses on a $118 billion portfolio of assets; B of A would absorb the first $10 billion and 10% of any further losses, so the government’s maximum exposure would be about $97 billion. Part of that guarantee was a non-recourse loan commitment from the Fed, basically meaning that the Fed would loan money to B of A, take the assets as collateral, and agree to keep the assets in lieu of being paid back at B of A’s option. In exchange, the government would get:

(a) An annual fee of 20 basis points on the Fed’s loan commitment, even when undrawn (if B of A drew down the loan, which it didn’t, it would pay a real interest rate). The loan commitment could be interpreted to be only $97 billion, so this comes to $194 million per year.

(b) $4 billion of preferred stock with an 8% dividend. That’s a dividend of $320 million per year; B of A can buy back the preferred stock by paying $4 billion.

(c) Warrants on $400 million of B of A stock. B of A was at $7.18 the day the bailout was announced and yesterday it closed at $17.61, so if Treasury had gotten an exercise price of $7.18, those warrants would be worth about $580 million now.

Continue reading

Benefits of Size?

Felix Salmon points out that Bank of America can now charge customers overdraft fees ten times a day (up from five). (Read the original Washington Post article if you want to be aggravated.) Well, I can do one better.

I recently had to track down some past bank records. Local banks? No problem, no fee. At Bank of America, however, they insisted on charging me $5 per page – even though they were breaking a state law forbidding them from charging a fee. (All I’ll say is that they weren’t allowed to charge a fee because of the characteristics of the person I was getting the records for and the purpose for which he needed the records.) I pointed out to the drone at the bank that she was breaking the law, but she insisted she couldn’t do anything about it and we would have to sue them to get the money back. And I believe her; the problem is almost certainly that requests go from the local branch to some central processing center, and there is no way for the local branch to tell the central processing center not to deduct the fee from your account.

Now perhaps this central processing center setup reduces costs for Bank of America. But do they charge lower mortgage rates? No. Do they offer higher savings rates? No. Are they too big to fail? Absolutely. Do things have to be this way?

Update: Some people have pointed out that you don’t actually have to sue B of A to get your money back. That is correct. In my state you can send them a demand letter and they should pay you. However, the problem is that because you are dealing with your bank, they can just deduct the money from your account and force you to fight them to get it back. And most people don’t want to deal with that.

By James Kwak

Bank of America Gets Quite a Deal

We have a deal.  You, the US taxpayer, have generously provided to Bank of America the following: one Treasury-FDIC guarantee “against the possibility of unusually large losses” on a pool of assets taken over from Merrill Lynch to the tune of $118bn, and a further Fed back stop if the Treasury-FDIC piece is not enough.  In return we receive $4bn of preferred shares and a small amount of warrants “as a fee”.  There is a $10bn “deductible,” i.e., BoA pays the first $10bn in losses, then remaining losses are paid 90% by the government and 10% by BoA.

We are also investing $20bn in preferred equity, with a 8 percent dividend.  There will be constraints on executive compensation and BoA will implement a mortgage loan modification program.  Essentially, this is the same deal that Citigroup received just before Thanksgiving, known as Citigroup II, which was generous to bank shareholders but not good value for the taxpayer.

This is more of the same incoherent Policy By Deal that has failed to stabilize the financial system, while also greatly annoying pretty much everyone on Capitol Hill.  Hopefully, it is the last gasp of the Paulson strategy and the Obama team will shortly unveil a more systematic approach to bank recapitalization; it would be a major mistake to continue in the Citi II/BoA II vein.

In addition, you might ponder the following issues raised by the term sheet

1. The $118bn contains assets with a current book value of up to $37bn plus derivatives with a maximum future loss of up to $81bn.  This is more detail than we got in the Citi deal, so there is evidently greater sensitivity to calls for transparency.  But the maximum future loss is based on “valuations agreed between institution and USG.”  What is the exact basis for these valuations?  From the term sheet, it sounds like we are talking mostly about derivatives that reference underlying residential mortgages.  Absent any other information, my guess is that they can easily lose more than $81bn – depending on how the macroeconomy and housing market turn out.

2. What is the strike price of the warrants?  This was controversial in the Citigroup II deal (because it was unreasonably high), but at least it was quite explicit up front.  The announcement is suspiciously quiet on this point, perhaps due to the recent spotlight on warrant pricing terms.

3. What kind of reporting will there be by BoA to Treasury, and what will be disclosed to Congress, in terms of the exact securities covered by this guarantee and how they perform?  The lack of information is a big reason why TARP became discredited and Capitol Hill is so concerned to see more transparency going forward.  There is nothing in the term sheet that reveals the true governance mechanisms that will be put in place, or how information will be shared with the people whose money is at stake (you and me, or our elected representatives).  I understand there is market-sensitive information present, but there are obviously well-established ways to share confidential information with members of Congress.

Overall, it feels like the latest (and hopefully the last) in a long line of ad hoc deals, which have done very little to help the economy turn the corner.  The new fiscal stimulus needs to be supported by a proper bank recapitalization program, as well as by a large scale initiative on housing.