Revisiting the Merrill acquisition

By Felix Salmon
June 11, 2009

All eyes are on Ken Lewis today: he’ll be testifying to Congress, and, according to the Reuters news planning email this morning, “Lewis is a fiery character and we will be looking for any departure from his script.”

Yet again we’ll be revisiting the history of the last four months of 2008, and specifically two decisions made by Lewis: the September decision to buy Merrill, and the December decision, in the face of pressure from regulators, not to pull out of the deal.

There’s no doubt that the September deal was done hastily. Matt Goldstein reckons that redounds badly on Lewis:

There’s still no evidence that anyone from the federal government was holding a gun to Lewis’ head when he and John Thain shook hands on the merger just as Lehman was spinning towards bankruptcy.

Lewis bears full responsibilty for that deal–along with his newly annointed chief risk officer Greg Curl. It didn’t take a rocket scientist or a mathematician to know that Lehman’s uncontrolled bankruptcy filing would have grave consequences for the financial system. Yet that didn’t stop Lewis and Curl from agreeing to buy Merrill. And at a price that was then a substantial premium to Merrill’s then share price.

If Congressional investigators want to do more than simple grandstanding they should begin by asking Lewis what kind of due diligence his team did in September when he inked the deal. They can start by asking whether he did any due diligence or was it just wishful thinking that everything would out.

But two facts are worth bearing in mind here. Firstly, the deal was of necessity rushed: Lewis and Curl simply didn’t have the time to do due diligence on a bank the size of Merrill over the course of one frantic weekend. But if the Merrill deal hadn’t been announced, there was an extremely high chance that Merrill would have collapsed in short order — and that at that point the shock waves from the Lehman-Merrill 1-2 punch would have been so systemically damaging that Bank of America itself would probably have gone under as well. Given that Lehman’s bankruptcy was obviously going to be harmful, it made some sense for Lewis to essentially draw a line under Lehman and show the market that at least Merrill was safe. If he didn’t, the entire financial system was in jeopardy.

Secondly, essentially all deals done during the financial crisis could reasonably be considered contingent until they actually closed. I noted when Lewis announced the purchase of Countrywide that it wasn’t an acquisition so much as a call option, and after that a whole spate of announced deals ended up being unwound, including Chris Flowers’s acquisition of Sallie Mae and Citigroup’s purchase of Wachovia. Given the rushed nature of the Merrill deal, it was probably reasonable for Lewis to think that if his due diligence turned up some particularly monster black hole in Merrill’s accounts (as it did), he would be able to find a way to wiggle out of the deal somehow.

The problem was that Lewis didn’t wiggle hard enough. Faced with stern disapproval from Ben Bernanke, Lewis quietly stopped wiggling and went ahead with the acquisition, even though he knew it would be extremely bad for his own shareholders. What he should have done is simply told Bernanke in no uncertain terms that his fiduciary duty to his shareholders forced him to back out of the Merrill deal, even if doing so was going to cost him his job. It was when he buckled in December that Lewis made his biggest mistake — not when he agreed to buy Merrill in September.

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