Looking Back in Anger at the Crisis

It was Thursday morning, and Mr. Paulson was once again before Congress, as he had been so many times last fall, defending his actions during the financial crisis. This time the subject was the Bank of America’s $50 billion purchase last year of Merrill Lynch, which Mr. Towns’s committee had become almost bizarrely obsessed with. In the middle of all the important issues Congress is currently tackling, it has managed to devote three full days of hearings to this seven-month-old deal.

Each hearing has had only one witness: the first to be grilled was Bank of America’s chief executive, Ken Lewis. Then came the Federal Reserve chairman, Ben Bernanke. Thursday was Mr. Paulson’s turn on the hot seat. The questions, from both parties, were uniformly hostile.

“Mr. Lewis, isn’t it true that ...”

“Yes or no, Mr. Bernanke ...”

“Isn’t that why you issued that threat, Mr. Paulson?”

The congressmen claimed to be investigating the events of last December. You’ll recall that just weeks before the Bank of America deal with Merrill Lynch was supposed to be consummated — and after shareholders had approved it — Mr. Lewis suddenly got cold feet. With Merrill Lynch’s toxic assets rapidly deteriorating, Mr. Lewis called Mr. Paulson and Mr. Bernanke to tell them he was thinking of pulling out of the deal.

Terrified that this might set off renewed panic in the financial markets, Mr. Paulson and Mr. Bernanke persuaded Mr. Lewis to stick by the deal. Quietly, over the next few weeks, they agreed to lend Bank of America an additional $20 billion from the Troubled Asset Relief Program to help shore up the bank’s capital. (They also agreed to backstop some $118 billion in troubled assets — though that part of the deal was later abandoned.) The first time the world learned of the additional government assistance was when the bank made its quarterly financial disclosure in January 2009 — weeks after the deal had closed.

To the congressmen at the hearings, something nefarious must have taken place during those negotiations. But what exactly? Dennis Kucinich, a Democrat from Ohio, told me that Mr. Lewis’s failure to inform shareholders was a “potential violation of securities law.” He felt that Mr. Lewis had gamed the banks’ regulators to get more money.

Mr. Towns, for his part, seemed to think that Mr. Paulson and Mr. Bernanke should have fired Mr. Lewis as a condition of more bailout money — that the government had been too nice to an incompetent management. Republicans, meanwhile, felt that Mr. Paulson and Mr. Bernanke had overreached, using intimidation and threats to force through a private transaction. And they all cited e-mail from the Fed that expressed skepticism at Mr. Lewis’s motives, and emphasized the need to keep things quiet for as long as possible.

I had watched the first two hearings with a growing sense of bewilderment. It always seemed obvious to me that if the Bank of America-Merrill deal hadn’t gone through, Merrill Lynch would have been in a horrible position, akin to Lehman Brothers or the American International Group. The government very likely would have had to spend an awful lot more than $20 billion to save it. Surely, the end result was worth whatever arm-twisting and additional government aid was required.

So why the anger? Why the suggestions of “cover-up” and “lies”? On Thursday, as I watched Mr. Paulson being castigated, it dawned on me. Seven months later, with the palpable fear of a financial collapse largely subsided, it really all boils down to how you view what happened last year. Was it, as Mr. Towns believes, a bailout of a handful of unworthy but too-big-to-fail institutions? Or was it, in the eyes of Mr. Paulson, a rescue of a teetering financial system? My vote is for the latter.

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In retrospect, the events of last December have a kind of irrefutable logic. Mr. Lewis, scared by the mounting losses at Merrill, tells the government he is thinking of invoking the “material adverse event” clause in the contract to get out of it. Even though the clause is pretty airtight — among other things, it says that deteriorating assets are not enough to create a material adverse effect — it is still a useful weapon, and a common tactic. No matter what the actual wording, invoking it usually prompts litigation or a renegotiation of the terms, or both.

Mr. Paulson and Mr. Bernanke understand this, of course. But having just finished giving Citigroup another round of TARP aid, they fear that even a rumor that the Merrill deal is in trouble will set off a rerun of the awful events of last September, when the financial system melted down. They persuade Mr. Lewis to take one for the team.

“They needed to say to Ken Lewis, ‘You haven’t had very good capital ratios, and we’ve looked the other way,’ ” said Nancy Bush, a prominent bank analyst. “‘Now it is payback time. We’ve let you do deal after deal after deal. Now it’s time to take one on the chin.’ ”

That appears to be exactly what happened. Instead of renegotiating the deal with Merrill Lynch, Mr. Lewis wound up renegotiating it with the federal government. Mr. Paulson helpfully pointed out that as Bank of America’s regulator, the Federal Reserve had the right to remove him and his management team from their jobs if it no longer trusted his judgment. I can almost picture Mr. Lewis gulping as he listened to “Hammerin’ Hank” laying down the law.

Seen in this light, virtually all the Congressional objections seem almost laughably naïve. Mr. Lewis gamed the regulators? Hardly. Bank of America is paying 8 percent interest on the $20 billion. Unlike Goldman Sachs or JPMorgan Chase, it lacks the financial wherewithal to pay it back. And accepting the extra money means it has now taken as much overall TARP money as Citigroup, the very symbol of a crippled bank. Plus, of course, it has to abide by strict executive compensation rules. link....