Merrill, Lehman Are Goners

While most of us got to watch football this weekend, government officials and bank executives had to work overtime in the Big Apple to address the ongoing, ongrowing credit crisis. For those folks, seven-day work weeks are now the norm. Their task is to shuffle assets in a way that will assure investors that (a) they know what they're doing and (b) what they're doing will work. If the answer to either question is "no," financial markets will crash.

Last week came the announcement that Fannie Mae and Freddie Mac will be bailed out by U.S. taxpayers. The news this morning is that Merrill Lynch and Lehman Brothers will cease to exist: Merrill is being taken over by Bank of America, while Lehman is filing for Chapter 11 bankruptcy protection to allow more time for liquidating assets. Treasury Secretary Hank Paulson, apparently of the opinion that taxpayers have done their part, is holding firm for a private-sector workout. Meanwhile, the Federal Reserve (privately capitalized, remember) stands ready to lend funds to other troubled firms (think AIG). Trouble is, the Fed's firepower has already been cut in half year-to-date.

Merrill's demise is no surprise, as vultures have been circling since February. What is a surprise is the price that Bank of America is paying: $29 a share, or 70% higher than Merrill's stock price at the close of Friday's trading. (Too high, traders are saying this morning, as BAC is down five in the pre-market.) In a similar move last March, JPMorgan Chase got Bear Stearns at a substantial discount. So why the premium now for Merrill? In all likelihood, the Fed forced the deal. It remains to be seen whether BAC shareholders can be forced to approve the deal.

A stock-market rout is a distinct possibility today, but it is the price that must be paid for future economic recovery. The bad actors in the false prosperity of the past decade must be allowed to fail. Unfortunately, we will all share the pain in the years ahead. As market strategist Mike O'Rourke observes, "The problems will be the reverberation throughout the economy as access to capital becomes even tighter than it already is. It appears that the amount of de-levering the market is about to encounter in coming months will likely outweigh the benefits of last week's GSE program."

[update, Sept. 17--]
With Merrill Lynch saved from bankruptcy, will the firm satisfy Maine's claim to funds invested last year in MainSail II? A check of the Maine Treasurer's website reveals that the issue was resolved three weeks ago. Merrill has agreed to pay back the $20 million.