Your Tax Dollars At Work, Wall St. Edition
The New Republic, July 19, 2012
"To help save some cash in the event of a downgrade, Morgan Stanley was hoping to park a big portion of its $52 trillion derivatives portfolio inside its bank subsidiary—the portion of the company that functions as an old-fashioned loan-maker, not a hedge fund or investment bank. The reason for doing this is that it would lower borrowing costs that would otherwise shoot up when its credit rating dropped. Why? Because being a bank means you have lots of customer deposits, most of them insured by the federal government, and that you have access to really cheap loans from the Federal Reserve. If, say, you suddenly took a multi-billion-dollar bath on your derivatives bets, Uncle Sam would be there to absorb the losses, or at least help you manage them, and the bondholders who'd loaned you money wouldn’t feel the pinch. And, of course, the bondholders know that in advance, which is why they're likely to loan you money at reasonable rates in the first place. Hence the low borrowing costs.
Sounds like an ingenious plan—just have the taxpayers subsidize the riskiest part of your operation! And, indeed, it is. As the FT notes, most of Morgan’s Stanley’s American competitors, chief among them Goldman Sachs, already house something like 90 percent of their derivative book in their bank subsidiaries (versus a mere 3 percent for Morgan Stanley today).
Unfortunately, the folks at Morgan Stanley just can’t catch a break. Just as they were about to follow suit and mosey on over to the federal trough, the feds (well, presumably the FDIC, whose insurance fund would be on the hook for those losses) decided that having taxpayers stand between bondholders and trillions of dollars in derivatives bets might not be the greatest idea in the world. "