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Jun 05 2012

The Megabank Fantasy By The FDIC

After the latest gambling losses by JP Morgan Chase with its “London Whale” deal, the FDIC is still trying to sell the fantasy that they can resolve the problems created by the megabanks. Yves Smith at naked capitalism takes on that myth that was propagated by acting FDIC Chairman, Martin Gruenberg to continue with business as usual:

The guts of the latest FDIC scheme is to resolve only the holding company and keep the healthy subsidiaries, including all foreign subsidiaries, going on a business-as-usual basis:

   …the most promising resolution strategy from our point view will be to place the parent company into receivership and to pass its assets, principally investments in its subsidiaries, to a newly created bridge holding company. This will allow subsidiaries that are equity solvent and contribute to the franchise value of the firm to remain open and avoid the disruption that would likely accompany their closings. Because these subsidiaries will remain open and operating as going-concern counterparties, we expect that qualified financial contracts will continue to function normally as the termination, netting and liquidation will be minimal.

The subsidiaries would be moved over to a new holding company; the equity in NewCo would become an asset of the holding company now in receivership. The old equityholders would likely be wiped out and the bondholders may wind up taking losses.

This all sounds wonderfully tidy and neat, right? Problem is it won’t work. [..]

Remember that in the US, banks (ex Morgan Stanley) have their derivatives booked in the depositary, which means any losses to depositors as a result of derivatives positions gone bad would be borne by taxpayers. And as we’ve written at excruciating length with respect to the Lehman bankruptcy, the magnitude of the losses cannot be explained by overvalued assets plus the costs resulting from the disorderly collapse. Derivatives positions blowing out (as well as counterparties taking advantage of options in how contracts can be closed out and valued) were a major contributor to the size of the Lehman black hole. [..]

It would have been much better for the authorities to make a full bore effort to discourage the use of products that have limited social value and contribute to the excessive integration of firms and markets. Credit default swaps and complex over-the-counter derivatives top our list. But despite the severity of the crisis, regulators and politicians were unwilling to challenge the primacy of the bankers, with the result that the FDIC continues to pretend that an inadequate approach like Dodd Frank resolutions will work. With distress in Europe rising and Morgan Stanley looking wobbly, we are likely to see sooner rather than later how much the failure to implement real reforms will cost us all.

If this sounds all too familiar, it’s because this is just a repeat of the old an stale propping up of TBTF that got the economy into this mess in the first place. In other words, the tax payers will foot the bill for the megabanks gambling losses once again. Obama needs a whole new council of economic advisors with people who have better ideas like Paul Krugman and Yves.

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