Bank of America Still a Giant Mortgage Casino: Street Whispers

NEW YORK ( TheStreet) -- Bank of America ( BAC) may or may not have set aside enough capital to resolve issues associated with loans its Countrywide Financial unit made during the subprime mortgage boom. But it--like other big lenders--will remain a giant interest rate casino.

Bank of America CEO Brian Moynihan underscored that point during an interview with CNBC Tuesday.

"There is an idea that if you get a mortgage now and it's so far below what we think is sort of normalized interest rates that as we say: a moment on your lips, forever on your hips. I mean that thing is going to be stuck with you for a long period of time and we manage our balance sheet very close because of that. And what we mean talking about close is that the duration of our balance sheet's a couple--two and a half years or so. So a lot of mortgages we have we swap out the interest rate risk  because of that. As an industry and as a company we're all doing that," Moynihan said.

In other words, if Bank of America makes a loan at 4% and mortgage rates climb to 7%, the value of the mortgage on Bank of America's balance sheet will drop. So Bank of America buys derivatives to hedge that risk. Moynihan says all banks do that, which isn't true. Washington Federal CEO Roy Whitehead WFSL told me when I met with him in New York a few weeks ago that his bank doesn't do that because, "you take out all the profit if you do that."

Whitehead acknowledges he's facing a risk as well. But who is to say interest rates will go up relatively soon? They could remain where they are for another 10 years, as has happened in Japan.

Among the banks that do hedge interest rate risk, however, they will all do so slightly differently, and few investors will be able to understand exactly how they're doing it. What constitutes true hedging and how much of it to allow is the central question regulators will have to grapple with as they write the Volcker Rule as they have been mandated to do be the 2010 Dodd-Frank financial reform legislation.

It seems likely, for better or for worse, that banks will be allowed to do a great deal of hedging when the final rule is written. And so investors will still have to determine which bank they think is best at "managing interest rate risk," as they will put it, though the difference between that activity and gambling will always be a matter of interpretation.

-- Written by Dan Freed in New York.

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