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Tuesday, September 27, 2011

Bank of America: Downsizing From Smallness

Three years after the near-meltdown of Wall Street in September 2008, Bank of America announced that 30,000 jobs would be eliminated. That amounts to nearly 10% of the bank’s total work force. Over all, BOA was planning to cut $5 billion in annual expenses. The reason is transparent: continued losses stemming from the bank’s acquisition of Countrywide in January 2008 in spite of the fall of the U.S. real estate market and the related losses on sub-prime mortgage-backed CDOs. What could Ken Lewis have been thinking? At least in the case of his acquisition of Merrill Lynch, which was agreed to in principle in September 2008, the investment bank had already sold its $30 billion of toxic assets for over $7 billion in July 2008.
While the $29 per share price for Merrill seems excessive given that the investment bank was trading at only $17 at the time of the agreement, Fleming’s negotiating strategy (stressing the long run value over the short term market volitility) on Merrill’s side, Thain’s preference for a 10% stake/$30 billion line of credit from Goldman, and the sheer strategic fit between BOA and Merrill can explain Lewis’s offer-price being at a premium over the market price. Even so, with Lehman poised to file, the Goldman option would have been insufficient (or would likely have dissolved on the Monday of Lehman’s filing as the market tanked) and Thain would have taken $17 (or even down to $10) in the wake of Lehman’s filing.
According to reporter Greg Farrell (p. 183), Bank of America tended to deal with problems “by finding the quickest, near-term solution and lunging in that direction.” BOA “was not an organization that had the patience for deep, strategic thinking. It was an opportunistic company that preferred action of any kind to inaction.” Although much of the bank’s empire-building had taken place under McColl, the preceding “legendary” CEO, Ken Lewis’s acquisitions of LaSalle, Countrywide and perhaps even Merrill Lynch (to some extent) evince the sort of short-sighted and opportunistic lunging-without-thinking that can go with empire-building. Cutting 10% of the work force may be interpreted as a response to the market’s implicit verdict on Lewis’s shopping spree following Fleet. The losses stemming from Countrywide are evident enough; the case of Merrill Lynch is a bit harder to weigh.


Although Merrill proffered great synergy with BOA and could be picked up on the cheap, Lewis’s rushing to a deal over a weekend (with only about 12 hours for due diligence!) can also be considered as excessively risky, especially considering the history of hidden CDOs at Merrill (Semerci hid $30 billion then unfairly blamed them on his predecessor at Fixed Income). Had Merrill unloaded all of its toxic assets back in July? If so, what caused the $15.31 billion loss of Merrill Lynch announced only after the BOA shareholder vote on the acquisition in December 2008? Furthermore, did Lewis knowingly keep the mounting losses at Merrill from his shareholders as they were preparing to vote? At the very least, failing to disclose the mounting losses in real time was risky, even reckless, given what could be expected—namely,  the $50 billion potential liability that would face the bank from a stockholder suit. Even if Lewis decided not to disclose “non-material” losses because they were in line with Merrill’s results in 2007, was the CEO manipulating his stockholders while puffed up in the vainglory of empire-building? Furthermore, the condition of the market in September 2008 was not exactly ripe for making a deal to acquire a major financial institution. Lewis and Thain knew Lehman would go belly up when signed their agreement at 1am on Monday, September 16, 2008. 
As risky and perhaps even foolhardy as the Merrill acquisition may have been for Lewis, his acquisition of Countrywide defies any good sense. That he was being paid millions of dollars at the time suggests that the dysfunction at Bank of America may include corporate governance. Specifically, deferring too much to the CEO at the expense of the shareholder interest evinces a lack of accountability. Although BOA had a history of duality—splitting the chairman and CEO positions between two people—still the CEO may have too much influence.
Finally, a vital matter of public policy should not be ignored. Although it could be argued that Bank of America is being forced by its own history and the market to downsize, the question can legitimately be raised whether the market can or should be relied on to take faulty banks too big to fail down a notch. The very existence of Bank of America may involve more systemic risk than we should be prepared to accept. Relying exclusively on the market for the correction is, I contend, insufficient. The market can be insufficient in downsizing to a suitable size, or irrational exuberance can take hold such that a 10% reduction becomes a free-fall. That a bank such as Bank of America of over $1 trillion in assets is allowed to exist as a concentration of capital is itself a systemic risk. In other words, something is seriously wrong with the market mechanism for a bank such as BOA to have been able to become so big in spite of its modus operendi or corporate culture.



Sources:

Greg Farrell, Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-Collapse of Bank of America (New York: Crown Business, 2010).

Steven M. Davidoff, “For Bank of America, a Looming $50 Billion Claim of Havoc,” New York Times, September 28, 2011.