The Super-priority Status of Derivatives, Winner Takes All

April 13th, 2013

Published on Dissident Voice, by Ellen Hodgson Brown, April 11, 2013.

… Why Derivatives Threaten Your Bank Account:

  • The big risk behind all this is the massive $230 trillion derivatives boondoggle managed by US banks. Derivatives are sold as a kind of insurance for managing profits and risk; but as Satyajit Das points out in Extreme Money, they actually increase risk to the system as a whole. 
  • In the US after the Glass-Steagall Act was implemented in 1933, a bank could not gamble with depositor funds for its own account; but in 1999, that barrier was removed. Recent congressional investigations have revealed that in the biggest derivative banks, JPMorgan and Bank of America, massive commingling has occurred between their depository arms and their unregulated and highly vulnerable derivatives arms. Under both the Dodd Frank Act and the 2005 Bankruptcy Act, derivative claims have super-priority over all other claims, secured and unsecured, insured and uninsured. In a major derivatives fiasco, derivative claimants could well grab all the collateral, leaving other claimants, public and private, holding the bag.
  • The tab for the 2008 bailout was $700 billion in taxpayer funds, and that was just to start. Another $700 billion disaster could easily wipe out all the money in the FDIC insurance fund, which has only about $25 billion in it.  Both JPMorgan and Bank of America have over $1 trillion in deposits, and total deposits covered by FDIC insurance are about $9 trillion. According to an article on Bloomberg in November 2011, Bank of America’s holding company then had almost $75 trillion in derivatives, and 71% were held in its depository arm; while J.P. Morgan had $79 trillion in derivatives, and 99% were in its depository arm. Those whole mega-sums are not actually at risk, but the cash calculated to be at risk from derivatives from all sources is at least $12 trillion; and JPM is the biggest player, with 30% of the market.
  • It used to be that the government would backstop the FDIC if it ran out of money. But section 716 of the Dodd Frank Act now precludes the payment of further taxpayer funds to bail out a bank from a bad derivatives gamble. As summarized in a letter from Americans for Financial Reform quoted by Yves Smith:
  • Section 716 bans taxpayer bailouts of a broad range of derivatives dealing and speculative derivatives activities. Section 716 does not in any way limit the swaps activities which banks or other financial institutions may engage in. It simply prohibits public support for such activities.
  • There will be no more $700 billion taxpayer bailouts. So where will the banks get the money in the next crisis? It seems the plan has just been revealed in the new bail-in policies.

All Depositors, Secured and Unsecured, May Be at Risk: … //

… Super-priority Status for Derivatives Increases Rather than Decreases Risk:

  • Harvard Law Professor Mark Row maintains that the super-priority status of derivatives needs to be repealed. He writes:
  • … [D]erivatives counterparties, … unlike most other secured creditors, can seize and immediately liquidate collateral, readily net out gains and losses in their dealings with the bankrupt, terminate their contracts with the bankrupt, and keep both preferential eve-of-bankruptcy payments and fraudulent conveyances they obtained from the debtor, all in ways that favor them over the bankrupt’s other creditors.
  • … [W]hen we subsidize derivatives and similar financial activity via bankruptcy benefits unavailable to other creditors, we get more of the activity than we otherwise would. Repeal would induce these burgeoning financial markets to better recognize the risks of counterparty financial failure, which in turn should dampen the possibility of another AIG-, Bear Stearns-, or Lehman Brothers-style financial meltdown, thereby helping to maintain systemic financial stability.
  • In The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences, David Skeel agrees. He calls the Dodd-Frank policy approach “corporatism” – a partnership between government and corporations. Congress has made no attempt in the legislation to reduce the size of the big banks or to undermine the implicit subsidy provided by the knowledge that they will be bailed out in the event of trouble.
  • Undergirding this approach is what Skeel calls “the Lehman myth,” which blames the 2008 banking collapse on the decision to allow Lehman Brothers to fail. Skeel counters that the Lehman bankruptcy was actually orderly, and the derivatives were unwound relatively quickly. Rather than preventing the Lehman collapse, the bankruptcy exemption for derivatives may have helped precipitate it.  When the bank appeared to be on shaky ground, the derivatives players all rushed to put in their claims, in a run on the collateral before it ran out. Skeel says the problem could be resolved by eliminating the derivatives exemption from the stay of proceedings that a bankruptcy court applies to other contracts to prevent this sort of run.

Putting the Brakes on the Wall Street End Game: … //

… (full text).

(Ellen Brown is an attorney in Los Angeles and the author of 11 books. In Web of Debt: The Shocking Truth about Our Money System and How We Can Break Free, she shows how a private banking cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Read other articles by Ellen, or visit Ellen’s website Web of Dept).

Links:

Plutonomy and the Precariat;

The debt crisis: its cause is redistribution and its consequence debt servitude;

DEBTOCRACY;

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