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Was Bank of America Forced to Buy Merrill?

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Shares of Bank of America (NYSE: BAC  ) are now down almost 75% in the past three months, making this former bank bully's market cap substantially smaller than that of Wells Fargo (NYSE: WFC  ) and just half the size of former competitor No.1 JPMorgan Chase (NYSE: JPM  ) .

Most of the plunge came in the last week, as B of A's deal to purchase Merrill Lynch prompted a second helping of bailout funds to help cover massive Merrill losses. Shareholders are infuriated -- as they should be -- and have filed a class action lawsuit against CEO Ken Lewis and former Merrill CEO John Thain in protest. The outrage ultimately led to Thain's resignation earlier today.

Two key questions that investors want to know the answers to are when those seemingly "unexpected" Merrill losses came to light, and why the deal was still consummated after they were discovered.

Here's what we do know
One popular argument is that the Fed "forced" the deal down Lewis's throat. Is it true? Well, it certainly didn't start that way. When the deal was first struck in September, the The Wall Street Journal reported that "[CEO] Ken Lewis said … that he felt 'no pressure' from federal government regulators to sign the deal."

As the report describes, things began to unravel in mid-December, when the depth of Merrill's losses took Lewis by surprise. That prompted a visit to Fed chairman Ben Bernanke and Treasury Secretary Hank Paulson on Dec. 17, where Lewis confessed that buying Merrill was too much for B of A to swallow. Lewis felt that Merrill had faltered enough to claim a material-adverse-change clause, which might allow him to walk away.

According, again, to The Wall Street Journal, Bernanke and Paulson worried that a failed deal would ravage financial markets, and warned B of A that pulling out "would reflect poorly on [B of A] and suggest it hadn't done its due diligence and wasn't following through on its commitments."

Nothing suggests that the Fed "forced" a deal against Lewis's will. On the contrary, it seems more appropriate to say that Lewis forced Bernanke and Paulson -- who have a responsibility to protect the financial system -- to bail out his blunderous miscalculation. As Lewis himself put it, "We went to regulators and told them we would not, that we could not close the deal without their assistance."

Maybe it's just me, but "would not close it without their assistance" seems like a far cry from "I tried to back out, but they held a gun to my head."

Moving on
To me, the argument that the Feds forced this deal to happen (a) seems to be untrue, and (b) ignores what's really important: that Lewis swung for the fences without understanding the risks, and shareholders are now paying dearly for his mistakes.

Someone remind me again: why hasn't Lewis followed Thain out the door yet?

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase is a Motley Fool Income Investor recommendation. Bank of America is a former Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool is investors writing for investors.

Read/Post Comments (4) | Recommend This Article (22)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 22, 2009, at 8:13 PM, Seano67 wrote:

    I'm not sure what a class-action lawsuit would accomplish. I mean it wouldn't help any of the shareholders get their money back, would it?

    Either way, it'll be really interesting to see what happens here. Thain's already out (thank god), Lewis is clearly a dead man walking- and as to who they might turn to to try and right the ship, I have no idea. Whoever that person is, I wish him or her the best of luck, cause this bank and its shareholders might very well be screwed for years and years to come.

  • Report this Comment On January 22, 2009, at 9:20 PM, valari25 wrote:

    I am going to claim credit for this article! Really, it is all I have right now as I hope and pray that no company I own stock in cuts their dividend. I am looking at you WFC and GE!!!

  • Report this Comment On January 22, 2009, at 11:58 PM, sultanofbaseball wrote:

    The banks and financial institutions are all out of control. It is rather obvious that they spend way more than they have at the expense of their shareholders and the taxpayers who have to BAIL them out. The federal government has to nationalize these banks sell off all there assets if there are any. All banks asking for a BAILOUT must submit a financial report to the federal government so assets can be sold and then allow to restructure under tight supervision.

  • Report this Comment On August 25, 2011, at 5:37 PM, nicole1983 wrote:

    The GOVERNMENT forced the banks into making all those bad loans! The Government decided that homeownership was a right and not a privilege. Hello not everyone should own a home if they can't afford it. Also BoA was forced to buy that failing bank by the GOVERNMENT! So everything that is happening is because the GOVERNMENT did not let banks think for themselves. BoA employees are facing a possible buy out from another company, which is funded by the GOVERNMENT! If this happens many people will loose their jobs! Does this make sense? I think not! The Government needs to get their nose out of this and let the banks work it out they are banks for crying out loud they know what they are doing when it comes to money. They only end up messing up when the GOVERNMENT makes them do what they know they shouldn't.

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