Fact and Fiction Behind Too Big to Fail

Smothers Brothers — Fed-Style

“Mom always liked you best!”

Now Morgan Stanley knows how Tommy Smothers felt. The Fed is playing favorites with our biggest banks. An article by Tom Braithwaite, Tracy Alloway and Shahien Nasiripour in today’s Financial Times described the implications of Federal Reserve actions and a potential ratings downgrade on the bank holding company’s regulatory capital.

The Fed has allowed Goldman Sachs to move 90% of its derivatives into Goldman’s FDIC-guaranteed bank. When Goldman first reported to its regulators as a holding company in 2009, the amount was 84%. The Fed overrode the FDIC and allowed Bank of America to move Merrill Lynch’s derivatives into its FDIC-guaranteed bank subsidiary. BofA had 50% of its derivatives in the banking sub in the first quarter of 2009. At year-end 2011 it was 73%. Morgan Stanley’s derivatives were entirely outside its FDIC-guaranteed bank in the first quarter of 2009. At year end Morgan Stanley still had only 3% of its derivatives in its banking subsidiary. JPMorgan Chase and Citigroup had all their derivatives within the scope of the FDIC guarantee. These calculations are based on Office of the Comptroller of the Currency quarterly derivatives reports.

In Congressional testimony in June 1998 and April 1999, then Fed Chairman Alan Greenspan told Congress that the Federal Reserve did not support having new risky transactions within the reach of the FDIC guarantee, not even in a subsidiary of the bank. He did support the big financial institutions booking them in other sister subsidiaries within the bank holding company. So what has and is transpiring at the Fed now violates what even anti-regulation Alan Greenspan would support. Except for Morgan Stanley.

Goldman Sachs is an investment bank, and a stronger one than Morgan Stanley. Why should they be singled out for more favorable treatment than Morgan Stanley?

Should any of these largest banks get into deeper trouble, who will be paying out on their credit default swaps? Read the same OCC quarterly derivatives reports. The OCC states that five big banks dominate credit default swaps. Would Goldman be paid out again 100 cents on the dollar? Didn’t we learn anything from AIG?

Fairy Tale Capitalism: Fact and Fiction Behind Too Big to Fail

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Was the mortgage debacle the sole cause of the financial bubble's collapse? Do you believe those who say the elimination of Glass-Steagall barriers didn't contribute to its building? Fairy Tale Capitalism: Fact and Fiction Behind Too Big To Fail places the mortgage mess into a broader perspective. It explains how the Federal deposit guarantee was married to investment banking's trading intensity, why the Fed had no choice but to bail out the biggest banks and how derivatives played a poorly-understood, but equally important role in the crisis. In simple terms Emily Eisenlohr walks with those who live on Main Street down Wall Street's darker alleys.

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