Bank of America financial crisis
- 1 Financial crisis & bailout: Bank of America' s contribution
- 2 Too big to fail & bailout
Financial crisis & bailout: Bank of America' s contribution
Trading subprime mortgage securities
Although in 2001 Bank of America stopped issuing subprime mortgages, it continued to sell financial products backed by risky subprime mortgages from other lenders. A 2007 report of the mortgage-backed securities market revealed that, of 17 firms selling securities backed by adjustable-rate jumbo mortgages, Bank of America had the worst delinquency rates:
- “The performance illustrates one of the main causes of the U.S. foreclosure crisis: While lenders tended to be fairly careful with loans they planned to keep on their books, they took more chances with loans sold to investors. In one category of securities sold by Bank of America in 2007, 98% of the underlying loans were made with reduced or no documentation of the borrowers' incomes.” 
As the crisis in the subprime mortgage market began to unfold, Bank of America’s balance sheet suffered. In 2007, the bank posted a $3 billion loss on collateral debt related to the mortgage market. A report produced for the American Bar Association found:
- “While the company did not issue subprime mortgages itself, it was still exposed to subprime losses through its CDOs, complex debt instruments which were often backed, in part, by subprime mortgages. With mortgage defaults increasing, the value and risk related to these instruments could not be assessed.” ProPublica’s analysis of the 2008 financial crisis concludes that half of the trillion dollars that were lost (covered largely by taxpayers) stemmed from CDOs. 
In his January 13, 2010 testimony before the Financial Crisis Inquiry Commission  Bank of America CEO Brian Moynihan largely blamed the crisis on the excessive leverage of investment banks; the lax regulation of mortgage lenders by state governments and the political push to expand home ownership among disadvantaged groups. He said the crisis was not necessary, pointing to the bank’s 2001 decision to stop making subprime loans. He argued combining investment and commercial banking in one company was not a problem. In October 2007, as the bank was declaring losses on its trades in securities backed by subprime mortgages, Moynihan’s predecessor Ken Lewis had famously declared:
- “I've had all of the fun I can stand in investment banking at the moment.”
He did not comment on Bank of America’s role in packaging subprime loans and turning them into tradable securities, but did state that securitizing loans “reduced the incentives for some lenders to apply as strict credit underwriting standards for securitized loans than they may have applied if they were required to hold and service those loans in portfolio…” He argued nonetheless that securitization is essential to modern financial markets. Moynihan claimed that:
- “No one involved in the housing system – lenders, rating agencies, investors, insurers, regulators or policy makers – foresaw a dramatic and rapid depreciation in home prices.”
According to the Service Employees International Union's profile of BOA, the bank still packages and sells subprime securities. In September 2009, for example, the bank underwrote $239 million worth of securities backed by subprime loans. 
Trade in derivatives
According to the Office of the Comptroller of the Currency, Bank of America is one of the five banks that hold 97% of total derivatives  in the U.S. or $206.2 trillion worth. All of the largest derivative traders are banks that are considered too big to fail, so that their high risk derivative trading is done with the backing of taxpayers. Frank Partnoy, a former trader with Morgan Stanley, has argued that the 2008 financial crisis would not have been as extreme if not for the speculative derivative trades related to the housing market:
- “Without derivatives, the total losses from the spike in subprime mortgage defaults would have been relatively small and easily contained…Instead, derivatives multiplied the losses from subprime mortgage loans, through side bets based on credit default swaps. Still more credit default swaps, based on defaults by banks and insurance companies themselves, magnified losses on the subprime side bets.” 
Although derivatives can be used to hedge risk, they can also produce extremely high profits or losses. Regulation of this aspect of the financial industry was central to proposed reforms so that derivative trading could not destabilize the entire economy again. According to Washington Post columnist Harold Myerson, Arkansas Democrat Blanche Lincoln’s derivative reform proposal would have meant that:
- “no longer would banks that our government backs up with deposit insurance and access to the Federal Reserve's discounted interest rates be able to put taxpayers on the hook for their speculative bets: They could either continue as derivative-trading casinos or as government insured banks, but not both.”
The largest US banks lobbied hard to defeat regulation of derivatives. Bank of America and other large derivative traders created a new lobbying organization, the Credit Default Swap Dealers Consortium, to shape derivative regulation to favor banks. It was created in November 2008, just one month after a number of its members, including Bank of America, had been bailed out by the government. The New York Times reported:
- “The banks hired a longtime Washington power broker who previously helped fend off derivatives regulation.” (His views) played a pivotal role in shaping the debate over derivatives regulation."  Bank lobbyists warned that U.S. regulation could drive derivative markets offshore and decrease the availability of the credit needed to get the economy going.
Commenting on the $700 bailout the U.S. government had provided to the financial industry through the Troubled Asset Relief Program (TARP), Bank of America CEO Brian Moynihan told a Congressional committee that TARP was:
- “an important step to restore confidence in our financial and prevent systemic consequences that would have affected every company and individual in the country.” We in the financial services industry are humbled that such support was needed, and grateful that it was provided.”  However, the aggressive lobbying by Bank of America and the other big banks to stave off regulation of derivatives suggests otherwise.
- “One thing I can confirm is that Wall Street has had many of their people -- lobbyists, and their people advocating against key parts of this reform. Sometimes I see them as I’m going into a senator’s office and somebody’s coming out… Bankers have a point of view because they want to protect their market. There are five large financial firms that are concentrated in this market, and they benefit and earn billions of dollars for their shareholders.” 
Too big to fail & bailout
The implicit government guarantee of TBTF institutions became explicit in October 2008, when Federal Reserve Chair Ben Bernanke and the Treasury Secretary made a public commitment “that the government would act to prevent the failure of any systemically important financial institution.” As part of the government’s overall bailout for the banking industry, two programs, the Systemically Significant Failing Institutions Program and the Targeted Investment Program (TIP), were created especially for Bank of America, Citibank and AIG; due to what administration officials viewed as their critical role in the economy. In addition to the $25 billion Bank of America received from Treasury’s Capital Purchase Program in 2008,  the bank received an additional $20 billion in 2009 from TIP, which enabled it to take over Merrill Lynch. TIP was intended to “stabilize the financial system by making investments in institutions that are critical to the functioning of the financial system.” The program was supposed to invest government funds:
- “to avoid significant market disruptions resulting from the deterioration of one financial institution that can threaten other financial institutions and impair broader financial markets and pose a threat to the overall economy.” 
The U.S. Department of Treasury, the Federal Deposit Insurance, and the [[Federal Reserve] also provided guarantees for $118 billion of Bank of America assets, committing taxpayers to take on 90% of Bank of America’s losses if the bank lost more than $10 billion. 
The government did not discipline Bank of America and Citigroup in the same way as it did AIG, even though all three institutions were singled out for special treatment from the Treasury due totheir significance to the economy. The Congressional Oversight Panel for the financial bailout noted in its December 2009 report that “Treasury required changes in senior management, and diluted the interests of shareholders when the government received a 79.9 percent equity interest in AIG. By contrast, despite providing Bank of America and Citigroup with exceptional assistance, Treasury did not require them to make changes in management. Furthermore, it did not dilute shareholder interests in Bank of America. Treasury has not explained the rationale behind the differences in treatment.”
Bank of America repaid $45 billion to the U.S. government in December 2009.
When Nations bank took over Bank of America in 1998, under the new name of Bank of America – it was the largest bank acquisition in U.S. history. The CEO at the time declared “Bigger is indeed better.” The combining of these two financial giants was just one example of what the Consumer Education Foundation describes as the “merger mania” that saw 11,500 US banks merge between 1980 and 2005.
Bank of America’s Too Big To Fail (TBTF) status when it was bailed out by the US government in 2008 was the result of a strategy of aggressive expansion.
Ken Lewis, CEO from 2001 until 2009, was criticized for empire building at the expense of shareholders. Bank of America took over FleetBoston for $47 billion in 2003 FleetBoston itself was the result of a 1990’s wave of mergers of New England banks that ended up with FleetBoston being the seventh largest US bank when it was bought by Bank of America. In 2006 Bank of America acquired credit card giant MBNA for $34 billion to create the largest credit card company in the US. In 2008, it bought Countrywide, the largest US mortgage lender, for $2.8 billion. 
The financial crisis has produced even bigger financial institutions, with the major banks being the big winners since they were able to buy out their competition and grow even larger. By 2009, Bank of America had grown to the point where its assets represented 16.4 % of US total gross domestic product. In announcing Bank of America’s 2009 buyout of Merrill Lynch, Bank of America CEO Ken Lewis emphasized the advantages such an enormous company would have: "Combining the leading global wealth management, capital markets and advisory firm with the largest consumer and corporate bank in the U.S. creates the world's premier financial services company with unrivalled breadth and global reach." 
Criticisms of TBTF banks
In their book, Thirteen Bankers: The Wall Street Takeover and the Next Financial Meltdown, Economists Simon Johnson and James Kwak argue for the break up of the six largest US banks. They define the “too big to fail” (TBTF) problem:
- “Certain financial institutions are so big, or so interconnected, or otherwise so important to the financial system that they cannot be allowed to go into an uncontrolled bankruptcy; defaulting on their obligations will create significant losses for other financial institutions, at a minimum sowing chaos in the markets and potentially triggering a domino effect that causes the entire system to come crashing down.” 
They further identify four main threats to the economy posed by TBTF banks:
1) When these institutions are threatened by bankruptcy, the government has to bail them out. Creditors can demand the government compensate them in full for the loans they have made to the bank because they know there is no credible threat that the government will allow it to fail.
2) TBTF institutions have incentives to take big risks for the potential of high rewards with the certainty that they will be bailed out by taxpayers if they run into trouble. Johnson and Kwak point out that “Ordinarily, creditors should refuse to lend money to a bank that takes on too much risk; but if creditors believe that the government will protect them against losses, they will not play this supervisory function.” 
3) TBTF have an unfair competitive advantage because with their implicit government guarantee they can borrow at lower rates than smaller banks.
4) Regulatory efforts to minimize high risk behavior will tend to be blocked due to the political power TBTF banks wield. Johnson and Kwak predict continuing financial crises if the response to the 2008 crisis does not include breaking up TBTF banks. They state: “solutions that depend on smarter, better regulatory supervision and corrective action ignore the political constraints on regulation and the political power of the large banks.” 
While some financial institutions disappeared during the financial crisis, others, like Bank of America emerged larger and even more powerful. Returning big banks to profitability has been a strategy of the Federal Reserve and the Treasury Department to restore financial stability. CEO Brian Moynihan acknowledged when he testified before Congress that the financial industry had “caused a lot of damage.” But he argued that while the big banks had been bailed out by the government, they had paid back their bailout money in full and had not “imposed any losses on taxpayers.” Moynihan clamed there would be costs to the US if the government tried to limit the size of banks, with losses of economies of scale and the ability of US banks to compete internationally. He warned that overly simple reforms could “end up hamstringing the U.S. financial system and economy...” 
Takeover of Countrywide
In August 2007, Bank of America bought a stake in Countrywide Financial Corporation, even though by then, due to the rapid deterioration in the housing market, no financial institution would loan Countrywide money secured by its mortgage assets.  The bank made a deal in January 2008 to purchase Countrywide outright. CEO Ken Lewis commented at the time that Countrywide was, “really - at the grass-roots level - a very well-run mortgage company.”  Two weeks later, Countrywide posted losses of $422 million.  Bank of America subsequently dropped the name “Countrywide Home Loans” and renamed it “Bank of America Home Loans”.
As part of its rescue of the financial system, the Federal Reserve set up a special investment vehicle named “Maiden Lane LLC” to buy risky assets and remove them from the balance sheets of financial institutions. Included in Maiden Lane’s purchases are $618.9 million worth of securities backed by Countrywide mortgages that were granted with little borrower documentation. These mortgages are now rated far below investment grade and the government is unlikely to recover all of the money it invested in them. 
In June 2008, the State of Illinois sued Countrywide, alleging it had committed fraud against borrowers through deceptive lending practices.  At the same time, California’s Attorney General also sued Countrywide, accusing the company of causing thousands of foreclosures and creating "mortgage instruments that did great harm to individuals and the community.” Despite the evidence of troubles at Countrywide, Bank of America stuck to its plan to acquire the mortgage lender and the deal went through in June 2008.
To settle the lawsuits with Illinois, California and eight other states, Countrywide, as part of Bank of America; came up with an $8.4 billion loan relief plan for those holding its mortgages. In June 2010, Bank of America paid $108 million to settle a Federal Trade Commission case that charged Countrywide with extracting excessive fees from borrowers facing foreclosure. Bank of America paid $600 million. Countrywide’s auditor, KPMG, paid another $24 million in August 2010 over shareholder claims that Countrywide concealed risky lending standards. 
New problems stemming from its Countrywide acquisition continue to plague the bank. In June, 2010 the State of Illinois sued Countrywide again, this time over racial discrimination in its lending practices. A state study concluded that minorities were charged more in fees and were steered towards subprime loans more often than white borrowers in similar situations. State Attorney General Lisa Madigan stated:
- “Countrywide’s illegal discriminatory lending practices destroyed the wealth and dreams of thousands of African American and Latino homeowners. Bank of America needs to be held accountable by taking financial responsibility for cleaning up the devastation of the predatory company that it chose to take over.” 
Takeover of Merrill Lynch
Bank of America acquired the brokerage firm Merrill Lynch for $50 billion in January 2009.  After the acquisition, it was revealed that Merrill Lynch had lost $15.8 billion in the last quarter of 2008. During this time, billions of dollars in bonuses had been paid out early to key staff. Former CEO, John Thain had spent lavishly during the crisis on decorating his office (for example, an $87,000 rug.) Bank of America stock plummeted from $33 a share before the deal wentto a low of $5.50 in the following weeks.  At the time, Merrill Lynch had two main operations, a profitable wealth-management company, with 17,000 financial advisers; and a trading company that invested in high-risk, high-return securities backed by subprime home mortgages. In 2007, Merrill had to write down $8.4 billion due to declines in house prices and increased foreclosures. In 2008, it sold off $31 billion of securities at huge losses with the strategy of isolating the firm from the housing crisis. 
Merrill was accused of not being open about the extent of its exposure to the subprime lending housing market and concealing it through off-balance sheet devices. In October 2007, Merrill reported its investment in the subprime market as $15 billion. Only three months later, it revealed that the figure was closer to $46 billion.  When the scale of Merrill Lynch’s losses became known, Bank of America was able to convince the Treasury Department to provide an additional $20 billion in bailout funds, for its takeover to proceed. Yet, weeks before the deal went through, Merrill had given out $3.6 billion in bonuses ahead of schedule. Four top executives alone received $121 million dollars. According to New York Attorney General Andrew Cuomo:
- “One disturbing question that must be answered is whether Merrill Lynch and Bank of America timed the bonuses in such a way as to force taxpayers to pay for them through the deal funding.”
The Wall Street Journal reported that Bank of America had a private bonus agreement with Merrill that allowed for bonus payments of $5.8 billion. Cuomo filed fraud charges against the bank, for not revealing to its shareholders the extent of Merrill Lynch losses and for misleading the government in order to get the additional $20 billion dollars. He called the bank's behavior “just egregious and reprehensible."  The Securities and Exchange Commission (SEC) sued Bank of America for not disclosing to its shareholders the extent of Merrill Lynch’s losses and the $3.6 billion accelerated payment of bonuses, before they voted on the acquisition. District court Judge Jed Rakoff refused to approve the original $33 million settlement agreed to by the SEC and Bank of America. He reluctantly approved it only after the penalty was increased to $150 million. In reviewing the settlement, he harshly criticized the SEC for being too lenient, that the punishment was “"half-baked justice at best.” Judge Rakoff expressed concern that the SEC settlement was unlikely to dissuade other corporate executives from doing the same thing, since the settlement involved was:
- "very modest punitive, compensatory, and remedial measures that are neither directed at the specific individuals responsible for the nondisclosures nor appear likely to have more than a very modest impact on corporate practices or victim compensation.” The judge stated that the settlement "penalizes the shareholders for what was, in effect if not in intent, a fraud by management on the shareholders."
Merrill Lynch and investment bank leverage
In 1975, the SEC’s trading and markets division ruled that investment banks must maintain a debt-to-net capital ratio of less than 12 to 1. In 2004, following extensive lobbying by the investment banks, the SEC, under chairman Christopher Cox, authorized five investment banks to develop their own net capital requirements. This enabled investment banks to push borrowing ratios to as high as 40 to 1. The five investment banks were Goldman Sachs, Morgan Stanley, Lehman Brothers, Bear Stearns, and Merrill Lynch. This very high debt-to-reserves helped lead to the financial crisis of 2008 by weakening the ability of these institutions to recover from losses from risky CDO and CDS.
According to Lee A. Pickard, Director of the SEC’s Division of Market Regulation when the 1975 12-1 rule was ordered:
- "The SEC modification in 2004 is the primary reason for all of the losses that have occurred."
At the time of its purchase by Bank of America, Merrill Lynch was leveraged at a ratio of 35.5 to 1.
Profiting from AIG bailout
The Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) has sharply criticized the handling of the bailout of insurance giant AIG. In a November 2009 report, SIGTARP concluded:
- “The very design of the federal assistance to AIG (meant that) tens of billions of dollars of Government money was funneled inexorably and directly to AIG’s counterparties. ...By providing AIG with the capital to make these payments, Federal Reserve officials provided AIG’s counterparties with tens of billions of dollars they likely would not have received had AIG gone into bankruptcy.”
Federal Reserve officials refused to use their influence to get the banks to take some losses on their AIG deals, though they knew that their $85 billion bailout of AIG would immediately be used to pay off AIG counter parties; not to restore the viability of the insurance company. In calculating the ultimate costs to taxpayers of bailing out the banks, SIGTARP argued that the bailout of AIG should be included.
Bank of America was one of banks that got paid with government bailout funds for its deals with AIG. Newsweek reported in January 2010:
- “AIG did end up funneling significant bailout money to U.S. banks that had already been bailed out themselves under the Troubled Asset Relief Program. As AIG counterparties, Goldman Sachs got $12.9 billion, Bank of America got $5.2 billion, and Citigroup got $2.3 billion.” 
- Bank of America’s Mortgage Record Takes a Hit: Report Shows Mortgage-Backed Securities Issued in 2007 Among the Industry’s Worst Performers, Globe and Mail, February 25, 2009
- “Collateralized Debt Obligations,” New York Times, (updated) July 21, 2010
- Task Force on Regulatory Reform of the Banking Law Committee of the American Bar Association, p. 173, November 2009
- “Banks’ Self-Dealing Super-Charged Financial Crisis,”, ProPublica, August 26, 2010.
- “Brian T. Moynihan, CEO, President, Bank of America: Testimony to FIC, Financial Crisis Inquiry Commission, January 13, 2010
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- “Times Topics: Derivatives,”, New York Times, (updated) December 13, 2010
- “Hope rises for real financial reform,”, Washington Post, April 21, 2010.
- Frank Partnoy, F.I.A.S.C.O – Blood in the Water on Wall Street, 2009, pgs. 267-268.
- “Hope rises for real financial reform,”, Washington Post, April 21, 2010
- “In Crisis, Banks Dig In for Fight Against Rules,”, New York Times, May 31, 2009
- “Clinton Team Should Have Done More on Derivatives, Gensler Says,”, Bloomberg, May 1, 2010
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- “Clinton Team Should Have Done More on Derivatives, Gensler Says,” Bloomberg, May 1, 2010
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- Simon Johnson, James Kwak, Thirteen Bankers, March 2010, p. 12.
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- Simon Johnson, James Kwak, Thirteen Bankers, March 2010, p. 201.
- Simon Johnson, James Kwak, Thirteen Bankers, 2010, p.204.
- Simon Johnson, James Kwak, Thirteen Bankers, 2010, p.207.
- Brian T. MoynihanTestimony to Financial Crisis Inquiry Commission, FCIC, January 13, 2010
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- ”Profile: Countrywide Financial Corporation, New York Times, (updated) October 15, 2010
- “Countrywide sued by state over lending,”, Los Angeles Times, June 26, 2008
- “Countrywide to pay $600 million to settle lawsuits,”, USA Today, August 6, 2010.
- “Madigan Sues Countrywide for Discrimination Against African American and Latino Borrowers - Alleges African American and Latino Homeowners Paid More for Their Mortgages than They Should Have,”, Illinois State Attorney General’s Office, June 29, 2010
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- Bank of America-Merrill Lynch: A $50 Billion Deal From Hell, Wall Street Journal, January 22, 2009
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- “Merrill’s Risk Disclosure Dodges Are Unearthed,”, New York Times, August 9, 2010
- “Top Four Merrill Bonus Recipients Got $121 Million,” Bloomberg, February 11, 2009
- “Cuomo Blasts Merrill Over Bonuses,”, Wall Street Journal, February 11, 2009
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- “Judge OKs ‘half-baked’ SEC-Bank of America accord,”, Reuters, Feb 22, 2010
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- Julie Satow, Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers, New York Sun, September 18, 2008
- slide 20, Professor Andrei Shleifer. The Financial Crisis and The Future of Capitalism, Harvard Economics Dept., June 2009.
- “Factors Affecting Efforts to Limit Payments to AIG Counterparties,”, Office of the Special Inspector General for the Troubled Asset Relief Program, November 17, 2009
- “What’s Haunting Timothy Geithner?” Newsweek, January 8, 2010