This is a story about greed and corruption, about blind ambition and selfishness. The merger between Bank of America and Merrill Lynch during the financial crisis is historically significant, and represents the unethical behavior of many executives on Wall Street. John Thain, former CEO of Merrill Lynch, and Ken Lewis, former CEO of Bank of America, were so focused on their own pursuit of greater compensation and power that they ignored the warning signs and understated the severity of the financial situation.
SETTING THE STAGE
Before we get into the ethics of the deal process, we must go through the events that led up to the merger. With regard to Merrill Lynch, the company had historically been the “crown jewel” of wealth management. Its army of 60,000 employees and 16,000 financial advisors were the best in the business. It wasn’t until a man named Stan O’Neil became CEO and allowed the firm to accumulate $40 billion in collateralized debt obligations (CDOs) during his tenure, making Merrill Lynch one of the largest CDO issuers in the world. Through his pursuit of greater short-term returns, he exposed Merrill to very high levels of risk, which eventually led to huge losses to the firm (Muolo and Padilla).
John Thain took over the firm when O’Neil was forced to resign in 2007. Having worked as the number 2 guy to Hank Paulson at Goldman Sachs, and being the engineer of reform to the New York Stock Exchange, John Thain was known as “Mr. Fix-It” as well as “the smartest guy in the room” (Farrell 144). Thain was highly regarded by most on Wall Street and saw the offer as an opportunity to lead a great company out of financial distress. Thain attempted to raise money to cover the losses by Merrill by distributing equity to shareholders and selling off the some of the firm’s CDOs, which he believed fixed the problem. Thain publicly claimed and repeated many times that Merrill Lynch had become “well capitalized” and that it was now in good financial condition. In an interview he said, “Today I can say we will not need additional funds. These problems are behind us. We will not return to the market” (154). He was wrong.
With regard to Bank of America, the firm had grown significantly through mergers and acquisitions and had become one of the largest banks in the country. Based in Charlotte, Bank of America was not a typical Wall Street firm, putting less of an emphasis on compensation and more of an emphasis on the betterment of the firm. Having previously been named Nationsbank, the Bank of America name came from the company’s acquisition of the California regional bank, Bank of America, in 1998. Because most of the company’s operations were in retail banking, the company did not have a large stake in CDOs (Rothacker).
Ken Lewis became the CEO of bank of America in 2001 after Hugh McColl retired. McColl had built Bank of America into the commercial banking empire that it was in 2001 and Lewis, previously being McColl’s second in command, wanted to prove that he could be an even better CEO than McColl (Finkelstein). Lewis had brought himself from modest beginnings in Mississippi, and had developed a fierce competitiveness to be the best. He hated the New York investment bankers, who he believed were only motivated my compensation and prestige. The documentary Breaking the Bank describes his motivation as “he wants to give the finger to New York and to Wall Street and he wants to beat them at their own game” (Kirk). When Lewis became CEO, he made a list of all of the companies he wanted to acquire and one after another Bank of America acquired them. From FleetBoston Financial in 2004 to MBNA in 2006 to LaSalle Bank in 2007 to Countrywide in 2008, Lewis grew Bank of America. He had approached Merrill Lynch several times previously but Merrill had always declined his offer. Merrill was the prize that McColl couldn’t get (Kirk).
Once the financial crisis hit in 2008, Merrill Lynch was incurring staggering losses. Greg Farrell describes the situation well:
The losses resulted from the steady erosion in value of assets already on Merrill’s books, exacerbated by the demise of Bear Stearns. Merrill’s operations actually performed well in the quarter, but not well enough to make up for the write-downs associated with those toxic assets (Farrell 167).
If Lehman Brothers failed, Merrill Lynch would be next to go under. Merrill needed to find a buyer. However, John Thain continued to talk about the strength of the Merrill Lynch balance sheet and that the company would prevail. Thain did not want to sell the company, mainly because that would entail that he lose his precious CEO position. Farrell notes “Thain loathed the idea of giving up his job as CEO of Merrill Lynch, and felt revulsion at selling to a company that proudly proclaimed itself to be the Walmart of banking” (256-257). He tried very hard to get financing from Goldman Sachs in exchange for a minority stake in Merrill, but was ultimately unsuccessful. Merrill Lynch’s President Greg Fleming tried to reason with Thain that Bank of America is the best option for the firm, but Thain continued to drag his feet. Thain even considered the notion that “if he decided to play a high stakes game of ‘chicken,’ the government would probably have save Merrill Lynch, because it would have to save Morgan Stanley and Goldman as well, or risk Armageddon in the capital markets” (280-281).
Ultimately, Thain was forced to call Bank of America CEO Ken Lewis to talk about a stake in Merrill Lynch as other banks began to discuss cutting their credit lines to Merrill. Ken Lewis, however, was not interested in a stake.
“I’m not interested in a 9.9 percent stake,” he said.
“Well, I didn’t come here to sell the company,” Thain responded.
“That’s what I’m interested in,” Lewis said (Rothacker 108).
In his head, Lewis had the opportunity to be the king of Wall Street. He wanted Merrill and Merrill needed him. After some discussion, Thain reluctantly agreed to sell the company but added, “You can’t do it on the cheap…otherwise we won’t do it” (Farrell 279). At the time, Merrill’s stock price was trading around $17 a share (it was near $60 just eight months earlier). Executives at Merrill Lynch consistently told Thain that Merrill should be prepared to take anything that Bank of America offered, arguing that Merrill may cease to exist if there is no deal, causing 60,000 people to lose their jobs, but Thain refused, saying that Merrill Lynch must be paid at a premium to the market price. Thain wanted $30 a share for a $17 stock, a huge premium for a company threatened by bankruptcy (Farrell).
Ken Lewis was not known for being stingy on deals; when he wanted something, he was willing to pay top-dollar for it as a matter of pride and prestige. Bank of America came in with an offer of $29 per share, an incredible overvaluation in the opinions of most financial professionals. Even President Greg Fleming was shocked at the offer, “Kelly, Heaton, and Wetzel had warned him that he would have to accept whatever offer BofA made, but Fleming believed he could get $30 and $29 was close enough. Touchdown, and the extra point is good!” (293). Thain, however, did not share Fleming’s excitement:
He called Thain, brimming with excitement.
“John, I’ve got $29 a share!” Fleming said, practically shouting.
“Okay,” said Thain, devoid of emotion. “Well, that’s not bad.”
Fleming listened, incredulous, as silence filled the line.
“All right,” Thain finally said. “I want thirty” (293).
Fleming knew that $29 was Bank of America’s final offer and any attempt to raise it would jeopardize the deal and it took several hours to get Thain on board, but he finally agreed. Bank of America was to buy Merrill Lynch at the price of $50 billion or $29 per share, a 70.1% premium to where the stock was trading (295).
But the deal wasn’t over. Treasury Secretary Hank Paulson had pushed to see that the companies merge before the market opens on that Monday, as Lehman had was about to fail and a huge selloff was expected. The deal was supposed to be signed at 10:00 p.m. on Sunday, but continued until past 1:30 a.m. because Thain wanted to discuss compensation in a time of dire conditions. He appeared not to care about the severity of the situation, but rather about increasing his compensation as much as possible (Kirk).
After the deal had been done, Lehman Brothers went bankrupt on Monday and Hank Paulson summoned the leaders of the large banks to participate in the TARP. Bank of America took $20 billion to help with operations (Kirk).
As the months carried on, it became apparent that Merrill Lynch was going to post huge losses for the fourth quarter of 2008. The company’s toxic assets were destroying the firm’s balance sheet. These numbers should have been disclosed to shareholders before they voted on the merger. Ken Lewis decided not to include the Merrill losses and the merger was approved by shareholders. By December, Merrill Lynch posted losses of over $15 billion, more than any other quarter in the company’s history. Lewis feared that losses of this magnitude could take Bank of America under, so he wanted out of the deal through what is known as a MAC clause (material adverse change), which allowed a merger to be broken if a large change occurred in one of the companies. This usually is followed by shareholder lawsuits, but Lewis determined that the losses from Merrill would be far greater than any lawsuit (Kirk).
Paulson, after hearing that Lewis was considering a MAC, then all but forced Lewis to go forward with the deal. The government infused another $20 billion into Bank of America to offset the losses in addition to a promise to cover another $118 billion on Merrill Lynch’s toxic assets. This essentially nationalized Bank of America, putting the government in control of the way it would operate. Once the losses at Merrill reached the public, shareholders were enraged that Lewis had not disclosed this information before the merger had been voted upon. Ken Lewis had hurt Bank of America by buying Merrill Lynch to feed his own ambition. John Thain was not without ridicule either. He had paid out bonuses totaling over $4 billion to top Merrill Lynch executives just days prior to the merger agreement. Ken Lewis used this information to assign blame to Thain and try to take Thain down with him (Kirk).
The purchase of Merrill Lynch by Bank of America was historic on many levels. Once regarded as very respectable and even heroic CEOs, Ken Lewis and John Thain destroyed their reputations with one deal. Ken Lewis was overly ambitious, blinding him to the flaws in purchasing Merrill Lynch within the economic conditions that were crushing the system. Lewis’s ambition and lust for becoming the king of Wall Street also caused him not to disclose vital information to shareholders, as he wanted the deal to be completed. When it became apparent that Merrill would not create the empire that he wanted, Lewis attempted to break the merger, leaving the economy hanging in the balance. John Thain risked the jobs of 60,000 employees to get $1 on an offer from Bank of America that was already way above what the company was worth. He also delayed the signing of the deal so that he could further increase his own compensation. Thain was driven by greed, Lewis by ambition. These types of behaviors and motives from bankers on Wall Street are what sent us into the Great Recession. I only hope that we can learn from their mistakes.
Farrell, Greg. Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-collapse of Bank of America. New York: Crown Business, 2010. Print.
Finkelstein, Sydney. “Why Ken Lewis Destroyed Bank Of America.” Forbes. Forbes Magazine, 3 Mar. 2009. Web. 10 Nov. 2013.
Kirk, Michael. “Breaking The Bank.” PBS. PBS, 16 June 2009. Web. 10 Nov. 2013.
Muolo, Paul, and Mathew Padilla. Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis. Hoboken, NJ: John Wiley & Sons, 2008. Print.
Rothacker, Rick. Banktown: The Rise and Struggles of Charlotte’s Big Banks. Winston-Salem, NC: John F. Blair, 2010. Print.
- Crash of the Titans (bizgovsoc9.wordpress.com)
- Say Good Bye to the Merrill Bull (ritholtz.com)
- Drumbeat for Ken Lewis Resignation Builds (ritholtz.com)
- Thain: ‘Too Big to Fail’ Issue Still Not Resolved (ritholtz.com)