Bernanke Throws Stockholders and Taxpayers Under the Bus.

In my April 26th blog post, entitled “There is a crack in everything,” I wrote about Ken Lewis testifying under oath that Federal Reserve Chairman Ben Bernanke broke the law in a number of ways in December 08 and January 09, in regard to Bank of America’s acquisition of Merrill Lynch. Ways that I predicted would prove to be of huge consequence. That scenario played out this week as Bernanke testified under oath before Congress and denied Ken Lewis’ claims.

The fall ‘08 banking meltdown for sure featured many tense stand-offs in corporate boardrooms. None, perhaps more tense than interactions between Bernanke and Lewis. Bank of America (B of A), at the time, was not one of the banks about to go under because of toxic investments. They had problems, but still had “liquidity.”. That is why Bernanke chose B of A to absorb the floundering Merrill Lynch, who had spent an entire year losing an average of 59 million dollars a day, and had only days left to survive.

By this time Bernanke already had “bailout fatigue” and was in no mood for gamesmanship or negotiating. He was pretty much just telling everyone how it was going to be. The deal was struck during the three week period in early fall that featured collapses, bailouts, and forced marriages affecting every Wall Street investment house. The problem with the deal between B of A and Merrill Lynch was that Lynch CEO John Thain was not done losing money yet. He doubled down on his already toxic mortgage securities, having misjudged where the bottom was.

By December ‘08, when the two companies began preparing for a January ‘09 closing, Merrill revealed another $16 billion in losses on top of $118 billion in toxins. A stunned Ken Lewis notified Bernanke that he was thinking of backing out of the deal, invoking “MAC” (Materially Adverse Change), a clause that would have allowed him to walk away from the deal without consequence.

This is the moment Bernanke crossed the line. He went from powerful financial regulator to illegal megalomaniac manipulator, when he (according to Lewis’ testimony under oath), told Lewis that would he would remove Lewis and his entire Board if Lewis invoked MAC. Whether Bernanke in fact had the power to do so, or whether it was just pretending he was King of the World is not something that I have read anyone commenting on. More importantly though, Bernanke went on to instruct Lewis not to disclose the losses to the SEC (Securities and Exchange Commission) until the deal closed, a serious violation of the law.

Clearly, the onus for disclosure was on Lewis. And these are serious laws, meant to protect investors, who must trust the system to give them honest information to make informed investment decisions. This goes to the core of why the confidence is gone from Wall Street. If Bernanke used his position to threaten Lewis to break the law, he too, is guilty, and should (and perhaps will) be prosecuted to the full extent of the law.

If the SEC can spend months and years going after Martha Stewart for an insider trading charge that involved, I can’t remember, $50 thousand or something, then surely the illegal manipulation of information about a deal in the tens of billions is actionable, especially when the net result deprived stockholders of the right to dump B of A before the toxins hit.

So far, the congressional committee is not buying the inconsistencies in Lewis’ and Bernanke’s stories. The committee’s ranking member, Darrell Issa (R-Calif.): “I for one personally doubt all these can be explained away.” Bernanke denies that what he told Lewis constituted a threat. It was just a “suggestion.” Trouble is, someone in Bernanke’s position has to be aware of the power he wields. Jason Chaffetz (R-Utah): “with all due respect, I’m just not buying that…I think that’s a threat, and I think it’s reasonable for the CEO and the board to take it as a threat.” Richmond Regional Fed Bank President Jeffrey Lacker has already supplied e-mail evidence that very clearly has Bernanke bragging about threatening Lewis and his Board with their jobs if they pulled out of the deal.

This is about more than the Fed Chairman overstepping his boundaries. One, it falls into the same disturbing pattern we have repeatedly seen during this crisis, one of protecting the high and mighty and handing the bill to investors and taxpayers. Two, at a time when new (much-needed) regulatory powers are being debated as possibly being given largely to the Fed, it raises important questions about whether the Fed already has too much power, and whether the Fed often uses that power to its own ends. Remember, the Fed is not answerable to Congress or the President, or to anyone for that matter. It has never been audited. Its creation in secret on Jekyll Island in Georgia in 1917, and its role ever since, is shrouded in mystery.

Also, does the Fed deserve more power after its dismal performannce managing the economy? Senator Chris Dodd (D-Conn.) likens giving the Fed more regulatory power to "a parent giving his son a bigger faster car after he just crashed the family station wagon."

Bernanke keeps claiming his actions were to protect us against a broader systemic risk. But this is starting to feel more like decrees made by “divine” right. And always to the benefit of the Devine.

The words were taken from my mouth before I could utter them, when Chris Rupkey of the Bank of Tokyo/Mitsubishi UFJ said “It does have a kind of a Watergate feel to it.” Except that Watergate was after all, nothing more than a petty burglary. More about the implication of the action than actual consequence of that action. I’m not sure that the burglary itself ever netted anything. But it was enough to bring down a President. This is much different. This is all about a person of vast power, entrusted by us regular people to protect the financial system we depend on, using that power to break the law and manipulate vast sums of money for the benefit of the financial elite.

Committee Chairman Issa has charged that the Fed has covered up its involvement in the merger and “deliberately hid” important details from other regulators. In an atmosphere where so much white collar criminality is being swept under the rug, probably because no one has the stomach to upset the fragile recovery with high-profile prosecutions, it will be interesting to see if Congress and/or the SEC can find the willpower to go after Bernanke.

Doug Friesen
June 27, 2009

There is a crack in everything

There is a crack in everything
Sunday April 26, 2009

The occurrence last week of a financial event so profound as to be the equivalent of a crack in the fabric of space/time went largely unnoticed and underreported. I speak of the under oath testimony of Bank of America Chief Ken Lewis to NY Attorney General Andrew Cuomo, wherein Lewis claims that in December 08 Paulson and Bernanke more or less blackmailed him into completing B of A merger with Merrill Lynch even after he learned huge additional losses by Merrill Lynch just before the deal was ready to close.

Here’s the back story: Earlier last year, when the banking crisis first started to unfold, then treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke stepped in to “save” Bear Stearns, by forcing a shotgun marriage to JP Morgan Chase. By the end of summer, Fannie Mae and Freddie Mac, the two giant quasi government mortgage houses also required bailout, to the tune of $200 billion, the largest US bailout ever. When venerable trading house Lehman Brothers appeared to be on the brink of collapse, Paulson and Bernanke demurred. They had bailout fatigue, and played “tough love” with Lehman. A worldwide financial panic ensued, and Paulson and Bernanke were widely vilified for failure to take the reigns.

In September, as almost every major bank and investment house on Wall Street started to come apart at the seams, the two were desperate to somehow save the rest of the financial system and prevent a worldwide collapse. Merrill Lynch, which had lost billions in toxic mortgage securities was paired up with Bank of America. At the time, Ken Lewis was enthusiastic about the deal, as they were picking up a Wall Street giant for pennies on the dollar, and one which nicely filled holes in their financial profile.

These deals are not easily done, and Merrill Lynch was operating independently in the fall of 2008 pending shareholder approval and transfer of assets. Meanwhile, Merrill Lynch CEO John Thain was a busy man. Not only did he take time for a $1.5 million re-do of his office, he kept aggressively trading mortgage securities. Not chastened by billions in losses over the past year, he apparently believed the market for them had bottomed, and there was money to be made. He was buying. The same dense brained hubris that lost Merrill Lynch and average of 59 million a day for the last year caused Thain to think he could still master the situation. By the time he was done, in December 08, Merrill had lost an additional 15.8 billion, a staggering amount of money.

Even then, on his way out the door, Thain wrote himself a $40 million bonus and handed out almost $4 billion in bonuses to his crew. This was the start of the Wall Street Bonus scandal, and was what caused New York Attorney General Andrew Cuomo to investigate. Thain offered to reduce his bonus to $10 million. Cuomo felt zero was more what he had in mind, and also aimed to shine a spotlight in some of the dark corners of this messy deal.

December 5, Bank of America shareholders approved the merger. That’s what Merrill was waiting for, and the following week, they quietly and quickly recorded their additional losses. According to sworn testimony, On December 14 Bank of America CEO Ken Lewis was informed by his CFO of the additional losses, described as “a staggering amount of deterioration.” Lewis had expected additional losses and some of these losses were known to B of A officials but nothing of this magnitude. December 17, Lewis informed Paulson that he was thinking of invoking a “MAC” clause. MAC, stands for “material adverse change,” and allows a partially completed merger to be legally rescinded without penalty if adverse conditions arise during the merger.

Paulson and Bernanke were also busy men during this time, charged with saving the free world from financial Armageddon. They were in no mood for gamesmanship, and bluntly told Lewis that if he did invoke MAC, he and his entire board would be removed. Most importantly, they told Lewis to keep quiet about the losses until after the deal closed January 1. Lewis replied “that makes it simple, let’s deescalate.” Paulson also told Lewis that the government would at some point make TARP funds available to restore the lost equity. When Lewis asked for that in writing, Paulson said no. The deal closed Jan 1 right on schedule, and the shareholders were not informed of the losses until the second week in January. As expected B of A’s stock cratered, investors lost billions, and taxpayers were stuck with another bailout.

As Dianne Francis writes in the Financial Post “the gang that couldn’t shoot straight shot investors in the head.” Sure, Paulson and Bernanke felt they were justified in their actions because they felt the failure of the Merrill/B of A merger posed a systemic risk. But does that mean they can throw shareholders under the bus in such a selective manner?

Here’s the thing: Paulson and Bernanke’s actions violate Securities laws, which require material facts to be disclosed in a timely manner. Thing two is that the onus for this disclosure rests entirely on the shoulders of the CEO, and in an eventual suit between shareholders and Lewis, which now seems more likely than not, the defense “the government made me do it” will not stand up in court. Lewis was free to say: “No deal, I’m disclosing”.

Does the government have the right to play high stakes poker with the pension funds of Retirees? Especially when the resulting damage is almost entirely to shareholders, while the CEOs and traders still get their bonuses? Once again the Titans of finance come out intact and the public is collateral damage.

Thing three is that it is inconceivable that Timothy Geithner, (now Treasury Secretary) as the chairman of the New York Fed at the time, was not kept in the loop on this.

Thing four is the burning question: What other lies and deceit by those in power have been perpetrated during this collapse to keep themselves in power. The only constituency not being bailed out or protected in any way is the public.

Thing five is that such a violation of the rule of law will inevitably shake the confidence of the very markets we are trying to fix. As I say in my recently published book The Age of Entitlement (www.amazon.com, www.AgeOfEntitlement.com): From the most powerful hedge fund trader to the simplest homeowner, … the lack of market discipline removes the foundation of every investors decision to part with his cash.

This story could have huge implications. Not only does it blatantly expose the lengths that those in charge of the economy will go to in order to keep existing power structures intact, it highlights a casual disregard for protecting the rights of shareholders and taxpayers, the very people these regulators are entrusted to protect.