Fed Emails Detail Ken Lewis' Delicate Dance

Oh!  What a tangled web we weave ...

Here are some of what I believe to be the key points in the series of emails going back and forth among Fed officials regarding the Bank of America / Merrill Lynch deal.

Though the emails are incomplete and a bit confusing, I have put them in chronological order to better detail the progression of events.

While a bit convoluted, the bits selected and highlighted should begin to tell the narrative of what really happened: Bank of America CEO Ken Lewis began to realize the magnitude of the problems facing Merrill Lynch - and his own company - and was doing a delicate dance with various Fed officials, at one point (according to a Fed email but "not recalled" by Lewis in testimony today) allegedly asking for formal Fed guidance on a deal, perhaps even a letter of Fed endorsement.   It is clear that Fed officials would not give Lewis a letter and indeed began openly discussing various lawsuits they knew were coming.   Note that the Fed also openly questions Lewis' knowledge of the Merrill Lynch problems.

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(12/19 from Richmond Fed official to Federal Reserve Board - Fed beginning to realize the magnitude of the financial problems) "The preliminary assessment on the ML loss numbers is that ML does not appear to be overly aggressive in some of its larger markdowns - though we can't yet say with certainty and for all positions - so the size of the losses/write downs may not (their emphasis) be overstating the problems at ML to a large extent in an attempt to 'kitchen sink' the losses in advance of the acquisition date. Details of the sources of the 'new' $4 billion in losses are being sought right now and that will be included in the analysis once we get a bit more clarity"

(Same email continued - Fed beginning to doubt Lewis) General consensus forming among many of us working on this is that given market performance over past several months and the clear signs in the data we have that deterioration at ML has been observably under way the entire quarter - albeit picking up significant [sic] around mid-November and carrying into December - Ken Lewis' claim that they were surprised by the rapid growth of the losses seems somewhat suspect.'

(12/20 email from Jeffrey Lacker to various Fed officials - self explanatory and seems to reference Ben Bernanke ) "Just had a long talk with Ben [Bernanke?].   Said they think the MAC threat is irrelevant because ¡ts not cred¡ble.   Also intends to make ¡t even more clear that if they play that card and then need assistance, management is gone. (Forgot to tell him KL is near retirement.)

(12/22 email from unknown to Fed official - Fed responding to Lewis' requests for some Fed legal guidance, potentially helping shift blame) [Lewis] had a question which I will address to Scott (also to Deborah).  He said he now fears lawsuits from shareholders for NOT invoking the MAC [material adverse change clause] given the deterioration at ML.  I don't think that's very likely and said so.   However, he still asked whether he could use as a defense that the gov't ordered him to proceed for systemic reasons.    I said no.  It is true, however, that we have done analysis that indicates that not going through with the merger would pose important risks to BAC itself.   So here's my question: Can the supervisors formally advise him that a MAC is not in the best interest of his company?  If we did, could he cite that in defense if he did get sued for not pursuing a MAC?

(12/23 response to above from unknown - You can see the Fed begin to set the state for its own defense and back Lewis into a corner) "Just to be clear, though we d¡d not order Lewis to go forward, we did indicate that we believe that going forward would be detrimental to the health (safety and soundness) of his company.   All that said, I don't think its necessary or appropriate for us to give Lewis a letter along the lines he asked.   First, we didn't order him to go forward - we simply explained our views on what the market reaction would be and left the decision to him.  Second, making hard decisions is what he gets paid for and only he has the full information needed to make the decision - so we shouldn't let him off the hook by appearing to take the decision off his hands."

(12/23 email from Fed official -  Discusses a potential lawsuit and how the Fed is starting to protect itself) "...Treasury gave our views on what we thought the likely effects would be of not proceeding [with a BAC/ML deal] but that's different than ordering Lewis to proceed.   I want to avoid the Fed being the centerpiece of the litigation.   Lewis needs to have every incentive to analyze the facts and document and justify his decision.   If he [Lewis] thinks he can rely on us, he'll assert there was nothing he could do and he can be reckless - not the right incentive.   Moreover, once we're in the litigation, all our docs become subject to discovery, and you'll remember from Deborah's presentation, some of our analysis suggests that Lewis should have been aware of the problems at ML earlier (perhaps as early as mid-November) and not caught by surprise."

(12/23 between Fed officials - Discussion of Lewis' liability) His [Lewis] potential liability here will be whether he knew (or reasonably should have known) the magnitude of the ML losses when BA made its disclosures to get the shareholder vote on the ML deal in early December. I'm sure his lawyers were much involved in that set of disclosures and-Lewis was clear to us that he didn't hear about the increase in losses ML recently.

(12/23 email from Richmond Fed official to Jeff Lacker - Discussing Lewis' own, growing fears) 'I think he is worried about stockholder lawsuits; knows they did not do a good job of due diligence and the issues facing the company are finally hitting home and he is worried about his own job after cutting loose some very good people."

(12/29 email from Kevin Warsh to Ben Bernanke and other Fed officials - Shows BofA hinting to Fed that it will need money) "Spoke with BofA folks this morning, mostly Joe Price (CFO).  They seem to have taken on board some of the ideas we discussed with them last week, but did not install a lot of confidence that they have a comprehensive handle on the situation.   Their views, however, are evolving towards asking for some relief to parent co [Bank of America] in addition to ML."

(12/30 email from a Fed official to Fed board members Don Kohn and Kevin Warsh - Rare insight into high-ranking Fed members discussing their PR strategy)  "Any help will depend on getting our arms around that, and then judging the market reaction to our a¡d.   Second, our potential solutions depend significantly on some amount of TARP money being available when it comes time to act and on the FDIC being willing to play a role like it did in C¡t¡.  BA won't want a loan, which is all we can do on our own. The availability of TARP money around January 20 will depend on Paulson's ability to convince Congress to give the funds to Tim, on Congress acting without imposing new restrictions on hows the funds are to be-used, and on whether a new, unexpected problem arises before January 20 (or whenever the next tranche is granted).  So we can't be sure at this point what we can do.   So I'd stick to the message you suggested before.   Consummating the deal is important to BA and ML as-well as financial markets.   Failure to consummate at this point would send bad signals about BA and ML as well as financial markets."