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US Bank Depositors Unlikely to Take Losses

Probably won't need this guy


A recent post by Ellen Brown at Web of Debt claims that US bank depositors could lose some of their money if the bank failed, citing this paper from the FDIC and The Bank of England. She quotes from the paper, bracketed material is her addition:

An efficient path for returning the sound operations of the G-SIFI to the private sector would be provided by exchanging or converting a sufficient amount of the unsecured debt from the original creditors of the failed company [meaning the depositors] into equity [or stock]. In the U.S., the new equity would become capital in one or more newly formed operating entities. …

Brown doesn’t mention the National Bank Depositor Preference Act, 12 USC § 1812 (d)(11). That law says that in a bank receivership, the depositors get first call on any assets. It seems almost impossible that a bank could lose enough money to cause losses to depositors. But I have other questions about the paper.

The Rosy Assumptions of the FDIC/BOE Paper

The paper is a joint exercise between the FDIC and the Bank of England. It is designed to help with the difficulties presented by international financial entities that are too big to fail. The parties agree that the strategy for dealing with a failed TBTF should “assign losses to shareholders and unsecured creditors”, p. 2, and there is where the problem arises. When you deposit money in a bank, the money belongs to the bank, and you become an unsecured creditor. You have the right to get the money back from the bank, but if it doesn’t have enough to go around, you are just one of many creditors. In the US, we ameliorate that problem through the FDIC, which insures your deposit up to $250K, and the distribution priorities.

Prior to Dodd-Frank, the FDIC only had the ability to take over a failed bank. According to the FDIC/BOE paper, under Dodd-Frank, the FDIC would take over just the parent company of the TBTF bank, leaving the subsidiaries in full operation. The assets of the parent would include the stock it holds in its subsidiaries. Those would be transferred to a bridge financial holding company and hopefully the subsidiaries would continue their operations under new management. The shareholders of the parent and probably the unsecured creditors of the parent would be wiped out.

The FDIC would evaluate the subs to make sure they are adequately capitalized, then transfer them into private hands. The FDIC/BOE paper says “By leaving behind substantial unsecured liabilities and stockholder equity in the receivership, assets transferred to the bridge holding company will significantly exceed its liabilities, resulting in a well-capitalized holding company.” P.6. Well, maybe.

Shouldn’t We Think About Derivatives?

The FDIC/BOE paper doesn’t use the word “derivatives”, and it’s not wise to worry only about the problems we’ve seen in the past. However, derivatives retain the ability to blow a hole in the balance sheet of a TBTF bank, as we saw in the London Whale trades. As an example, let’s look at JPMorgan’s balance sheet from most recent 10-K. Total deposits are nearly $1.2 trillion, and other debt totals about $950 billion of which some may be secured. Total net worth of the consolidated enterprise is $204 billion. The balance sheet includes an entry for trading liabilities, which includes anticipated losses on derivatives (10-K, p. 214). The figure was about $132 billion, of which about $71 billion is “derivatives payable”. P. 221. We get another estimate of exposure to derivatives from the OCC call reports on derivatives. According to the most recent figures , JPMorgan bank subs had a total credit exposure to risk based capital ratio of 228%. This is a crucial number:

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