Regarding The New Revelations About BofA's Purchase of Merrill Lynch

Yesterday's post discussed Citigroup's recent debacle in some detail. Thanks to long mismanagement and the choice of a novice as its latest CEO, the financial giant has become, essentially, a government-owned banking utility.

Now we come to the other, most recent ward of the government, Bank of America.

Back in December, when Merrill Lynch's shareholders voted to sell their firm to BofA, it seemed rather straightforward. True, BofA's Ken Lewis seemed to be missing the chance to step back and drive a harder bargain, with Merrill's continued weakening condition offering him that opportunity.

But, as I noted in this post from late 2007, commercial bank CEOs are notoriously less capable and effective than their (former) investment bank counterparts. Thus, Lewis' forbearance seemed to be just business as usual.

Now, however, from a spate of Wall Street Journal articles last week, we learn that surprise, surprise- Lewis refrained from backing out of the Merrill purchase due to coercion from Federal government officials.

So, once again, we see that the allegedly passive interest which the Federal government bought last year in our large banks is anything but. In BofA's case, Bernanke and Paulson dictated to Lewis that he must penalize his common shareholders in order to satisfy their demands, and conclude the purchase of Merrill Lynch.

But there's plenty of blame and shame to go all around the table of senior officials, government and private sector, in this travesty.

Lewis claimed that Merrill was a feasible purchase, stating even last Friday, according to the Journal,

"We did not expect the significant deteriorate in mid to late December that we saw."

Gosh, Ken. Isn't that what you are paid to do? Correctly anticipate evolving credit and market risks to your assets?

Apparently Lewis and his team either failed to conduct a proper, updated due diligence on Merrill, didn't insert sufficient clauses to provide for Merrill's asset value shrinkage, or simply did not know what they were seeing when they conducted their analysis of Merrill's books and positions.

Regardless of the reason, this blunder certainly must cost Ken Lewis what little credibility he still has with anyone- analysts, employees, investors.

Oh, and, to close the deal, Lewis then required a further $138B of US taxpayer money, from Treasury, to both provide adequate capital so that the resulting combined firm would pass muster on regulatory bases, as well as provide guarantees for losses on suspect Merrill assets.

It looks like we, the taxpayers, pretty much own another large commercial bank. Nationalization continues apace.

Then we come to John Thain. Reading this morning's Wall Street Journal article about his actions, it is nearly impossible to escape the conclusion that Thain knew very well he had misled Lewis into consummating the deal, while all along knowing of the serious, significant deterioration of Merrill's positions.

Thain disingenuously removed himself from New York during a critical week in December to ski in Vail, Colorado. His spokesperson claims Thain was 'working and available,' while others see him as having deliberately distanced himself from the gathering cloud over the transaction.

It's much more understandable why Thain chose not to revisit the transaction's desirability with his own board or shareholders. Per my prior, linked post, once again, an investment banker managed to out negotiate a commercial banker.

Seen from a distance, once again, we see the needless, expensive and private property rights-trampling behavior of government. Rather than have the excess, incompetent capacity represented by Citigroup, Merrill Lynch and BofA removed, their assets sold at market prices, and only healthy institutions left to compete, instead we have them all being propped up, polluting and delaying the process of the markets to cleanse the financial system.

As I noted in my post from October of last year, reviewing the Journal's interview with Anna Kagan Schwartz,

"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years." Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake. "

I think this past week has more than validated Ms. Schwartz' judgment. We're in for either a very long return to a market-oriented financial system of credit provision, or a very short journey to a fully-nationalized system of core credit provision.