Bank of America's (BAC) spectacular fall from grace has driven home two key points. First, even lenders that seem relatively safe from the credit storm can find ways to steer right into it, resulting in multibillion-dollar losses and brutal share sell-offs. Second, Washington's $138 billion rescue package of the Charlotte lender, cobbled together on the fly, is failing.
As the Obama Administration moves to change strategy to stabilize the banks, it will have to think bigger. The bailout, as it's currently structured, has amounted to little more than a temporary tonic to help BofA digest its controversial acquisition of brokerage giant Merrill Lynch. "It's a Band-Aid," Leslie Rahl, president of consulting firm Capital Market Risk Advisors, says of the government's remedy for ailing banks. "It's a camouflage, as opposed to a real solution."
For all the weekend meetings on Capitol Hill to craft the rescue packages, Washington still hasn't addressed the underlying problem: Billions of dollars of toxic securities and loans languish on banks' balance sheets. "It's like a cancer that you have to cut out," says Frank Partnoy, a law professor at the University of San Diego. The surgery won't be cheap. BofA will need another $80 billion to withstand coming losses and build up a healthy amount of capital, estimates Paul J. Miller Jr., an analyst at research firm FBR Capital Markets (FBCM).
To be sure, no bailout could possibly solve all of the banks' problems, many of them self-inflicted. CEO Kenneth D. Lewis, under fire from angry shareholders, probably wouldn't be in this mess if he hadn't agreed to buy Merrill just after BofA's $4.2 billion purchase of mortgage lender Countrywide Financial and its $21 billion acquisition of banking chain LaSalle Bank. From the outset there was trepidation among BofA's rank and file about the Merrill purchase, particularly since the deal was forged during the same mid-September weekend that Lehman Brothers was filing for bankruptcy. One BofA derivatives expert, fresh off a 14-hour day, was summoned to a law office at 2 a.m. to inspect Merrill's numbers. In all, BofA had just 24 hours to check the books and make a decision. "It would take much more time than we were given to value [Merrill's illiquid] assets," says a senior BofA employee who works closely with management.
History shows that BofA's diligence was less than what was due. Lewis' advisers inside and outside the company expressed doubts about the Merrill deal, then valued at $50 billion—far more than its $27 billion market value at the time. But Lewis was ultimately swayed by his director of corporate planning and strategy, Gregory L. Curl, the architect of previous transactions. By the time the deal closed, Merrill's market price was less than $20 billion. A BofA spokesman says the due diligence on the Merrill transaction was adequate, noting that losses grew dramatically in December because of "market phenomena."
Now the hastily arranged deal is laying bare a host of problems. Investors are growing impatient: Since October, shares of BofA have fallen by around 70%. And some insiders are losing faith in Lewis and his senior management team. Employees on the trading floor are riffing on Lewis' dictatorial style, referring to the CEO as Kim Jong Il, the North Korean leader. On Jan. 28, BofA's directors issued a statement backing Lewis.