File under "hubris"

Let's turn back the clock to September 15 when we watched BofA acquire Merrill Lynch.  BofA CEO Kenneth Lewis was at the peak of smugness.  I wrote:

I watched the press conference with the John Thain and Kenneth Lewis (CEOs of Merrill Lynch and Bank of America, respectively) as well as the CNBC interview with Lewis.  Mr. Lewis looked like the cat that ate the canary.  He certainly gives the impression that this is the deal of a lifetime.  Who knows?  He may be right.

Of course, it was only after that press conference that the true magnitude of Merrill's problems became known.  Sort of like getting reservations to a five-star restaurant only to find when you get there that the chef has left the building.  So what do you do?  Well, you've been wanting to eat there all your life, and you're not going to get any reservations anywhere else now, so you dutifully take your seat and place your order.

And so BofA went right on with the deal because they've always wanted a piece of that business, and where else are they going to go?

Back at the restaurant without a chef, the only question is not if but how much will the quality suffer.

BofA had no idea how much Merrill had gone down hill.

Back at the restaurant, the food arrives.  It's lousy, but you swallow it down, not wanting to offend... or cause a run for the exits.

BofA considered it their patriotic duty.  (NY Times)

Mr. Lewis told analysts that he was surprised to learn in December, three months after the bank snapped up Merrill Lynch in a shotgun deal, that the magnitude of losses at the brokerage was far greater than expected. He said he had considered walking away from the deal at that point, but was persuaded not to, partly by regulators who feared that a failure to seal the deal could set off a new round of panic in the markets.

The decision to stick with Merrill despite its problems, he said, was patriotic. "I do think we were doing the right thing for the country," Mr. Lewis said.

And then you're handed the bill.  Only then does it sink in.

Mr. Lewis said he had considered trying to renegotiate the price once he learned the extent of Merrill's losses. But he feared that the length of time required for a new shareholder vote would put Merrill and the markets at risk. More important, he said, the government did not want to risk new turbulence in financial markets if the deal were to be delayed.

Rather than argue with the waiter (very undignified), you pay the bill and appeal to a higher authority.

"In recognition of the position that Bank of America was in, both the Treasury and the Federal Reserve gave us assurance that we should close the deal and that we would receive protection," Mr. Lewis said.

Oh, and did I mention that you're paying for this meal with someone else's money?

BofA shareholders aren't exactly thrilled about this patriotic act.

So where do they go from here?  Unfortunately, options are limited.  In the eyes of many, BofA is too big to fail.  They should get assistance from the TARP.  However, this will be a test of the system to see if the government can get an adequate stake in the bank to minimize risk to the taxpayer.  If this is more of a short-term solvency issue, then there is less to worry about.  But there are no easy answers.  The only thing that appears certain is that, ex post, BofA overpaid.  Tough luck.  Cover it with the TARP to contain the damage (this is probably a less objectionable use of it than some uses) and answer to the shareholders.

That meeting will look a lot different than the Sept. 15 press conference.