In mid-December, Bank of America struck a deal behind closed doors with top U.S. financial officials: BofA could count on all the help it needed to cover the losses at Merrill Lynch, whatever they turned out to be. The important thing was for the deal to go through. The Treasury Department disclosed overnight that it would be investing $20 billion more in BofA and was teaming up with the Federal Reserve and FDIC to backstop losses on a $118 billion pool of troubled assets.
According to today's Wall Street Journal, Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson made the guarantee because they feared that if BofA were to pull out, it would shock the fragile financial system. But the deal has angered some of BofA's shareholders, who wonder why the troubles at Merrill weren't disclosed before the Dec. 5 shareholder vote to consummate the merger.
The timeline, according to BofA, goes like this: BofA didn't know of the losses before the vote. But after the vote, things got much worse. By Dec. 17, less than two weeks later, the outlook was so bad that BofA chief Ken Lewis traveled to Washington, D.C., and received assurances from Paulson and Bernanke that they'd fill the breach.
Here's how a BofA spokesman tells it:
"Beginning in the second week of December, and progressively over the remainder of the month, market conditions deteriorated substantially relative to market conditions prior to the Dec. 5 shareholder meetings. So Merrill wound up making adjustments for the quarter that were far greater than anticipated at the beginning of the month. These losses were driven by mark-to-market adjustments which were necessitated by changes in the credit markets, and those conditions change on a daily basis."
Some observers don't buy the idea that market conditions suddenly went south after the vote. One investment adviser and BofA shareholder tells the Journal that BofA simply "didn't do proper due diligence" on the deal.
It is indeed a remarkable turnaround. The deal occurred without government assistance in the chaos of mid-September, when Lehman Brothers and AIG toppled. A month later, the Treasury Department announced that it had invested $125 billion in eight of the nation's biggest banks. BofA was among them, reaping $25 billion ($15 billion for itself and $10 billion more for Merrill). But Lewis said that BofA had taken the money reluctantly. Even in late 2008, he told employees, "These were funds we did not need and did not seek."
Now, along with Citigroup, BofA is at the top of the list of TARP recipients with $45 billion total.
And like the government's entanglement with Citi, the taxpayers' exposure doesn't stop there. On top of that investment, the U.S. government has agreed to backstop a pool of troubled assets worth up to $118 billion. According to the deal, BofA will take the first $10 billion of losses. Beyond that, the U.S. government will absorb 90 percent of the losses, up to $97.2 billion.
As with a similar arrangement with Citi, the Fed, FDIC and Treasury will team up to cover those losses, so only $7.5 billion of that might be on Treasury's tab. Treasury is doing a fine job of spending tomorrow's money. As we pointed out yesterday, the administration is already spending the second half of the TARP funds, and with this deal, Treasury's total commitments rise to $385.9 billion, meaning that $35.9 billion of the second round of funds have been committed even before they're officially released.