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Should Paulson Have Forced The Merrill-bofa Merger?

The big story yesterday (and into today) was that Hank Paulson and Ben Bernanke basically forced Bank of America to go ahead with its merger with Merrill even after BofA realized it would be on the hook for over $15 billion in Merrill losses. The two officials also seem to have pressured BofA CEO Ken Lewis to keep quiet about the losses (or at least gave him the strong impression it was in his interest to do so) so that his shareholders wouldn't torpedo the deal. This all came to light thanks to an investigation Andrew Cuomo conducted into suspiciously large bonuses at the company.

I won't lie to you--it's not exactly a victory for transparency in economic policymaking. On the other hand, I do think the action is basically defensible, except for one quibble.

The issue comes down to this: Paulson and Bernanke knew the alternative to merging Merrill into BofA would be Merrill's collapse, which could lead to a systemic meltdown. So they had very good reason to make the merger go through. The problem was that, by essentially imposing that outcome, Paulson and Bernanke were shunting Merrill's losses onto BofA shareholders without their knowledge. 

In normal times, you'd obviously like to avoid that. When the fate of the entire financial system hangs in the balance, I don't think you want to hang yourself on shareholders' rights to information--even highly relevant information. What I think you do need to do, however, is make some small effort to compensate them, since it wasn't their company that screwed up (at least not on a massive scale like Merrill).

Instead, the $20 billion infusion of TARP money BofA got after the merger was on even less favorable terms than its previous TARP infusion. (BofA has to pay an 8 percent dividend on the government's preferred shares, compared with the 5 percent on its initial infusion.) It's not quite as bad a deal as it sounds, because the government also insured $118 billion in toxic assets at the time, most of them inherited from Merrill. And, politically, it would have been hard to give BofA more favorable terms. Still, if you're basically foisting losses on shareholders that their company didn't earn, it seems like you owe them slightly better. After all, Citigroup got basically the same terms on its TARP money (and a much bigger insurance policy), and it created the mess all by itself.

Interestingly, it sounds like BofA CEO Ken Lewis wanted to get the terms of this future TARP injection spelled out on paper, to no avail. Here's the relevant portion of the Journal's transcript exceprts:

Mr. Lewis testifies about seeking a written agreement from Messrs. Paulson and Bernanke that the government would provide BofA with more TARP funds and guarantees if BofA went through with Merrill transaction:

Q: Did you ask for any agreement from them?

Mr. Lewis: There was a point after that that the board brought up the fact that we're relying on the words that obviously has some very prominent people and honorable people, but, boy, what if they don't come through? So I called Bernanke -- I don't know why I called him versus Hank -- and said, "Would you be willing to put something in writing?" And he said, "Let me think about it." As I recall, he didn't call me back, but Hank called me back. And Hank said two things: He said, "First, it would be so watered down, it wouldn't be as strong as what we were going to say to you verbally, and secondly this would be a disclosable event and we do not want a disclosable event."

Hmmm. Okay, well, I guess it could have been worse.

--Noam Scheiber