BOA eats for free from the public trough

In a previous post I promised to get back to you with some commentary about why Bank of America is feeding from a trough filled with your money.  Well, here are some interesting sources for you to check out yourself.

I would first like to say though that I am not an expert in banking matters and the relationships between who owns what and who owes what is anything but transparent.  For instance, State Street Bank, Boston received a $2 billion dollar bailout  from the Treasury Department despite the fact that they are the largest institutional investor in Bank of America.  This makes no sense to me.  If any one would care to comment and enlighten me as to why we need this merry-go-round of money on which every one of it's riders get's the brass ring I would be greatly appreciative of your insight.  Also, if any of you find a conflict between the sources sited in the following would you please point it out to  me.

But, on we go to Bank of America, which I am going to refer to as BOA because it saves me some typing and coincides nicely with the sense of unease one might feel if a "boa" constrictor was anywhere near their neck - or wallet in this instance.

There are two broad categories into which these forms of "bailouts" fall.  There is that category of money which BOA borrowed and has since paid back.  The other is the category of money which our government has guaranteed in the form of backstops to protect BOA in the event of certain losses.  This is your money folks. Yours in that the funds, if used would have to come through borrowing in the form of the sale of U.S. Treasury securities.  I say borrowing by the U.S. Treasury because, as we all know, we're flat broke at the national bank.

But for this commentary I am going to treat them all as the lesser of two evils, the backstops, because whether BOA actually got the money and paid it back or just got a crutch to lean on in the form of a guarantee against losses, the funds were made available to BOA in such a form of lending that you and I, the average person, could never hope to obtain.  In effect, a backstop is similar to a casino allowing you to keep gambling, but with the casino telling you, "don't worry about the losses, I got your back" while everyone else at the table has to ante up with their own money and pay up immediately.  Would you sit down at that poker table under those circumstances?  I think not.

There is a common saying that banks only lend money to those who can prove they don't actually need it. That is not entirely accurate.  They only lend money to those who need it for something they "want" and not to those who need it for something really need, like a car so they can get to work and thereby earn money to pay back what they borrowed.  In short, you either get they money from the bank because it's cheaper in the long run to borrow it rather than liquidate funds you have placed somewhere else, or you get the money from the bank because you have convinced them that you will have the means through which you will be able to pay them back from future income, primarily by demonstrating that you have paid back others previously, under the terms you agreed to with them.

So, let's assume two potential scenarios. One in which you are the ideal borrower and one in which you are an average borrower.  I won't even consider here the scenario in which you are the least ideal of borrowers because the outcome is so frightening that it's alarmist.

Scenario 1:

You  have maxed out your FICO credit score at 850.  There is no one anywhere other than God who can find anything negative to say about you.  You have "money" in the form of assets such as your 401k, an IRA,  your home is paid off and you have some rental income from other properties you own.  You want, but don't need to, add on to your home.  However, the restrictions on withdrawals, capital gains from withdrawing from your investments, or selling some property exceeds the value you place on the pleasure you would receive from this addition to your home.  So you go looking for a loan and get the best rate on a home equity loan of $30,000 at 6% APR for the term of 10 years since you just hate the idea of owing money for anything longer than that.  The total cost of that loan to you will be $24,582 in interest paid.


Scenario 2:


You have the average FICO credit score of 723.  Some few people, other than God, have negative things to say about you, but most people like you.  You have "money" in in the form of your 401k and a great deal of equity in your home, though you have not paid it off.  Again, for similar reasons, you can't or don't want to take money out of your 401k and you don't have anything in the form of assets to liquidate.  You also want to add a $30,000 addition to your home.  Because you have an average credit score, have sufficient equity to meets the requirements to borrow $30,000 against the equity you are deemed worthy of a loan, but at a higher interest rate of say 8%.  The total cost of that loan to you will be $36,589 in interest paid.


A huge difference of $12,007, or about 40% more than in Scenario 1.


Now, let's put BOA's numbers into those scenarios.

In these scenarios though, the amount borrowed is $140.5 billion. Based on the information cited in the following links with a simple five minute search on Google.


$15 Billion on 10/28/2008

$7.5 Billion government committed but as yet unused guaranteed backstop

$976 Million Home Affordable Program

$20 Billion Targeted Investment Program

$97 Billion Federal Reserve funds committed, but as yet unused, set aside against bank's potential losses from Merrill Lynch merger

Scenario 1:  BOA borrows $140.5 billion rather than liquidate assets.  Again, at 6% and a term of 10 years.  The total cost of that loan to BOA will be approximately $25.5 billion dollars in interest paid.


Scenario 2:  Again, at 8% and a term of 10 years.The total cost of that loan to BOA will be approximately $31.2 billion dollars in interest paid.


Huge number indeed.  But in truth BOA isn't paying so much as a dime.  Why is that so?  Because, we've made the previous assumption that BOA doesn't actually take a loan or make use of its assets by selling them to raise the cash they need, because it has the U.S. Treasury standing behind it whispering "don't worry about the losses, I got your back, keep playing."

Change whatever conditions you like from amount borrowed/guaranteed backstops for losses, the interest rates, the terms and none of those changes will affect the underlying conclusion that the transactions are costing BOA absolutely nothing.

That dear reader is known as the privatization of profits through the socialization of losses.  And that is how BOA and all those other institutions considered to be "too big to fail" because of the potential effect on our economy, took advantage of you and me, the people who have to pay off the money borrowed or which might need to be borrowed if those backstops against losses are ever realized.


Allow me to give credit to the folks at Bankrate.com  I used the information on overnight interest rates and their online calculators to obtain these interest charges.  I highly recommend the site as I have found them to be a reliable source for various interest rates and easy to use calculators that will show the real cost of your borrowing.  Any errors in these calculations are mine and not the result of their information or calculators.