"What sank Bank of America?
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- Economist.com | NEW YORK
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- Financial markets
WHAT sealed the fate of Bank of America? I was surprised by something Thomas Friedman said yesterday.
And many other banks — the ones that took on the most leverage like Citigroup and Bank of America — are in trouble because of all the loans on their books that can't now be repaid, such as auto loans, commercial real estate loans, credit card loans, corporate loans.
In the run up to the crisis, there was reckless behaviour on the part of Citibank, Lehman and Bear—but is it fair to put BofA in that category? By acquiring Merrill and Countrywide, BofA has lots of nasty things on its books and it has taken lots of government money. But a big reason why things are so dire is because it bought a bank in really bad shape, not because it engaged in irresponsible lending and took on too much leverage.
Not to say things would be so rosy if it had not bought Merrill. While BofA may not have been as exposed as other firms, according to William Patterson, executive director of CTW Investment Group (which claims its affiliated funds own 116m BofA shares), by March 2008 BofA had lost 30% of its market capitalisation from the previous year. That was largely the result of liquidity support agreements from the CDOs it issued.
Also, even tougher times may lie ahead. The original BofA is heavily exposed to the American consumer. That may be a problem if unemployment goes above 10%. BofA has lots of home-equity loans and credit-card default could turn out to be a big problem. But, its behaviour, prior to acquiring Merrill, would not have left it on the brink of explicit nationalisation. It seems by taking on Merrill, it also took on its poor image. That made things even worse by sinking confidence further.
So even if Bank of America did not behave as recklessly as Merrill, was the decision to acquire it equally irresponsible? A letter circulating today from Mr Patterson to Temple Sloan, the bank’s lead outside director, calls for the removal of Ken Lewis for making that decision.
The board, however, subsequently allowed Mr. Lewis to take outsized, reckless risks by acquiring Merrill Lynch in the midst of severe financial uncertainty. After hastily arranging the ill-considered acquisition, management then failed to disclose Merrill’s staggering fourth quarter losses prior to the shareholder vote on the merger. In addition, BAC’s senior management was reportedly aware of Merrill Lynch’s intent to distribute nearly $4 billion in bonuses at a time when Merrill Lynch was suffering heavy losses. It also appears that Mr. Lewis had the ability to prevent the payments under a previously undisclosed agreement.
Mr Lewis claims he had no idea how bad 4th quarter earnings were until the board voted. Though, a friend of mine who works at Merrill put the merger rather succinctly: “It’s like buying a house during Hurricane Katrina and then acting surprised later the house is uninhabitable because of flood damage."
Nonetheless, after Mr Lewis realised how bad things were at Merrill, he claims he tried to back out of the deal. But Hank Paulson pressured him to stay the course (with the understanding of $20 billion of new capital from the government).
It’s ironic that now BofA is being cast in the same light as the worst behaving banks. The decision to buy Merrill may have been bad for BofA. But can you imagine where we would be now if that same fateful weekend Merrill went down with Lehman, or if Mr Lewis did back out of the deal to buy the troubled bank? Things could be much worse, either that or the US government would explicitly own Merrill by now. Who knows? If BofA survives this, it may someday be glad it bought Merrill (assuming that house does not need to be condemned)."
Me:Don the libertarian Democrat wrote:
"Nonetheless, after Mr Lewis realised how bad things were at Merrill, he claims he tried to back out of the deal. But Hank Paulson pressured him to stay the course (with the understanding of $20 billion of new capital from the government).
It’s ironic that now BofA is being cast in the same light as the worst behaving banks. The decision to buy Merrill may have been bad for BofA. But can you imagine where we would be now if that same fateful weekend Merrill went down with Lehman, or if Mr Lewis did back out of the deal to buy the troubled bank? Things could be much worse, either that or the US government would explicitly own Merrill by now. Who knows?"
You make a good point, but let's follow through with some conclusions from this.
First, there was serious fear on the Sunday before Lehman went bust that, if they did, Merrill would follow. The actions of the following week to get the B of A to buy Merrill seem to argue that the fear was justified. Why then take the chance of letting Lehman go bust? Why not have given more aid to the B of A to buy Lehman?
Secondly, given the tax provisions of the original TARP that helped Wells acquire Wachovia, and all of the other actions, it's obvious that the plan to take care of these large businesses was to make them bigger. But what if the size was the problem?
Thirdly, since Bernanke and Bair have said that neither the FDIC or any other government agency can seize these large banks, what was the contingency plan if that occurred? Surely somebody must have asked what would happen if a large bank became insolvent. As best as we can tell, the plan was to turn the large banks over to other large banks with government help. That is the definition of a government guarantee. If the agency that seizes insolvent banks can't seize an insolvent large bank, and we don't let banks go bust in the US, that means that the government is financially committed to saving that bank. Period.
Finally, since you make the point that the B of A was pressured to and helped in the saving of Merrill, how can we help but conclude that the government now feels honor bound to save them?
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