A few readers have written in, spooked by Bank of America transferring $75 trillion (nominal value)
in derivatives from the Merrill Lynch unit to the commercial banking unit.
This could be just a clever accounting scheme to save Bank of America some
money. BofA has estimated that a two-credit rating
downgrade – which has already happened – would mean paying an
additional $3.3 billion in collateral or termination fees. Or, this could be
in preparation for a possible future bailout.
Regardless of the reason for the move, someone at risk
management messed up. They clearly performed a stress test of a two-rating
credit downgrade. I really wonder about the internal conversation after the
stress test. Did it go something like this?:
"Well, the stress test doesn't look good. If a two-step downgrade
happens, we'll have to switch all the derivatives to the commercial banking
unit. We're not sure if that's allowed, but we'll find out when we get
there." That doesn't exactly sound like a great contingency plan. Even
if this isn't related to a possible bailout, I'm concerned by the
unconventional risk strategy here.
However, our readers are more concerned with the
possibility of the federal government bailing out BofA
should these derivatives go badly. Of course that's a real concern; but why
is there sudden anxiety over this possibility? Folks, this is 2011, not 2007
– did anyone not expect Bank of America to receive a bailout in the
event of another crash? It's the second-largest bank in the US, only recently
dethroned by JP Morgan Chase. The Fed and Treasury won't let BofA go the way of Lehman Brothers.
The Fed has bailed out numerous banks, maintained
near-zero interest rates for three years, promised two more years of low
rates, enacted QE2, and most recently started to twist Treasuries. Perhaps if
BofA fails, these guys would show some restraint?
Let's not be naïve here. It doesn't matter where those derivatives are
– the commercial unit, the Merrill Lynch unit, or the Planet Mars Bank
of America branch expansion unit. As long as Bernanke and the boys are in power,
those derivatives are insured by the American taxpayer.
During 2008, bailout opponents warned the supporters of
creating a moral hazard with their actions. The proponents argued that this
was a one-time event. Even some supposed free-market types supported the
bailouts. And where are we now? Just look at Europe's situation with
Portugal, Ireland, and Greece – and most recently Dexia
Bank. Bailouts were not a one-time event – they have become the policy
norm for central banks and governments around the world. Unfortunately, the
possibility of a BofA bailout isn't news to me.
This guarantee has been baked in the cake since 2008.
Next up, Alena Mikhan and Andrey Dashkov of the metals team will report on the Renminbi Kilobar, a new way to
buy gold priced in the Chinese yuan.
Renminbi Kilobar –
Another Sign of China's Growing Role in the Gold Market
by Alena Mikhan
and Andrey Dashkov
This week the Chinese Gold & Silver Exchange
Society (CGSE) – a bullion exchange based in Hong Kong – started
trading gold quoted in Chinese yuan. The contract,
called Renminbi Kilobar
Gold, is promoted as offering investors a "double safe haven"
– exposure to both gold and an appreciating currency. This line of
thought nicely accompanies China's intention to boost the yuan's
international appeal. It is expected that this product will attract retail
and institutional investors alike from both the Chinese mainland and
Whether or not the yuan can
deliver its part of the "double safe haven plan," Renminbi Kilobar Gold trading
in the first day was strong, with 322 traded gold contracts totaling 112
million yuan (or US$17.5 million). The settlement
price ended up at 346.95 yuan per gram, or $1,693.9
This is yet another sign of how fast the gold
investment sector is growing in China. In 2010 investment was up 70% over
2009. In Q1 and Q2 2011 gold investment rose by 123% and 44% over the same
quarters of 2010 respectively. At such a pace, the Chinese market seems to be
swallowing virtually every ounce of gold it is offered. Haywood Cheung,
President of the CGSE, expects their new product to boost these
To make trading convenient for overseas investors,
trading hours have been set for 8 a.m. to 3:30 a.m. the next day, Hong Kong time.
Traders may choose to settle their trades either in cash or with spot gold
delivery. Also, there is apparently a mechanism for investors to buy with US
The main goal of this investment tool seems to be
promotion of the Chinese currency across the region and on the global scale.
However, the impact – intentional or otherwise – on Chinese
demand may potentially have positive implications for the price of gold.
We would not be surprised to see a similar offering in
India soon and will continue monitoring such developments to make sure our
readers are among the first to know if anything changes.
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