Here Come De Judge

Legislators won't do it. Neither will regulators. So how do we proceed with pest control on Wall Street? I'm talking about the investment bankers who have spent the past two decades padding their compensation by peddling risky derivatives to zombie investors. Their financial "engineering" (too good a word, as it implies that they actually made something useful) resulted in a dangerous shortening of time horizons, a dysfunctional allocation of resources, massive job destruction, a generational delay in economic innovation, and a crushing tax burden amortized in perpetuity. Other than that, good job, guys.

Throughout 2008 I held up Merrill Lynch as the arch symbol of this over-the-counter culture. When 2008 expired, so did Merrill Lynch, at least as a stand-alone company. But the culture lives on. By all rights Merrill would have--and should have--failed, just as Lehman Brothers did a year ago. But Bank of America, prodded by an oligarchy anxious to keep the game going, decided to take Merrill over.

The merger almost fell apart when, upon more careful examination, Merrill's assets proved too toxic even for an acquirer the size of BofA. Then came a comical sequence wherein the Three Stooges--Treasury Secretary Henry Paulson, Fed Chair Ben Bernanke, and BofA CEO Ken Lewis--slapped each other silly with threats and counter-threats. Ken-Doll thought about pulling out of the deal before the shareholder vote in December. Take this, said Hammerin' Hank, handing him an envelope stuffed with $25 billion in TARP dough. Not enough, said Lewis. Then we'll up the ante, said Paulson, throwing in another $20 billion in taxpayers' money and a guarantee to cover as much as $118 billion in Merrill assets. Still not enough, repeated Lewis. Look, you good-for-nuttin' empty suit, said Helicopter Ben, just take the money and keep your trap shut, or we'll fire you AND your entire board.

O.K., O.K., that's enough, concluded Lewis. BofA shareholders approved the deal, blissfully unaware that Merrill was ringing up billions in losses and paying billions in executive bonuses. Since then the Securities and Exchange Commission, embarrassed into action by New York's Attorney General, has accused BofA executives of withholding material information from shareholders. Convinced that its work was complete, the SEC then agreed to a settlement whereby BofA would pay the government a fine of $33 million while admitting no wrongdoing.

Here come de judge! (Remember that refrain popularized by comedian Flip Wilson forty years ago?) Last week U.S. District Judge Jed Rakoff threw out the settlement, finding it ridiculous that the victims of the alleged wrongdoing--the shareholders who own the company--would ultimately pay the fine (the judge's dissatisfaction is documented here). Instead, he ordered the case to trial. The SEC, having already blown the Bernie Madoff affair, has no choice but to proceed. It must prove the misconduct and identify the perpetrators, who presumably would then be subject to punishment. Yesterday the SEC pledged to "vigorously pursue" the case against Bank of America.

Pending the trial, Lewis continues to make out like a bandit, thanks to the largesse of the federal government. The various bailout programs enacted by Congress (TARP, TALF, TLGP, etc.) have boosted the stock prices of all the major banks. Lewis has seen his 4.7 million shares of BofA stock more than quintuple in value since March. So confident is he of his firm's recovery that he has arranged to cancel the $118 billion asset guarantee provided by the feds for the Merrill mess. Generous to a fault, Uncle Sam is accepting an exit fee of $425 million, or less than a tenth of the real value of the insurance as originally negotiated.

It will be interesting to see if the discovery process which Judge Rakoff demands finally assigns accountability for the ongoing financial calamity that threatens any meaningful economic recovery.

[update, 09-30-09:]
Lewis announced today that he will retire from Bank of America at the end of the year. He will leave with $135 million in pension benefits, stock, and other compensation. So what if Social Security goes bust!