Editor’s Letter: The Deposit Sugar Daddy
Humble pie never tasted so good. Who could have imagined that Merrill Lynch, the 94-year-old raging bull, would stumble so hard that it needed a takeover lifeline? Oh, and that the acquiree would be one of those big, personality-less banks that securities firms' reps used to frown on no less. Even more amazing, who could have imagined that Merrill financial advisors would actually be happy to be taken over by a bank such as Bank of America? I guess relieved is the better word. (I am not pretending we predicted the failure of Merrill, but in this column in August we tallied up the damage to Merrill's and others' balance sheets through the first quarter of 2008; we discovered that Merrill's write-downs represented 86 percent of Merrill's book value — or, put another way, the write-downs wiped out four-and-a-half years worth of profits. In September we called it a “near-death experience” that was probably not over. Yet we were blown away by the takeover announcement on September 15.)
It sounds illogical, but the unprecedented happens all the time. Yes, it seems a little shocking to have to return to S&L-style bailouts and shotgun mergers to shore up failing financial institutions. As of this writing, Congress had yet to vote on the Treasury's $700 billion toxic asset fund idea. After playing politics with it, I would imagine that Congress will probably pass it. But will the Resolution Trust Corp. idea, version 2, work this go around? It did back in the early 1990s. But with massive deleveraging under way and interest rates headed to zero, will classic monetary tools used by government work now? The really scary part was the Reserve Primary Fund's “breaking the buck,” due to the nearly $800 million in Lehman debt it now holds.
Now we're all told that the model embodied by Citigroup — the universal bank idea, the one that many were criticizing — is the wave of the future. Dick Bove, the Ladenburg Thalmann analyst, says in a September 22 research note, “The new financial system will be built around the commercial bank model. He predicts, “The commercial bank model will replace all others.” Goldman Sachs and Morgan Stanley have moved to restructure themselves as bank holding companies.
The new BofA, with the addition of Merrill Lynch, is indeed a beast (the deal has yet to be approved by shareholders as of this writing). On its own, BofA has $1.6 trillion in tangible assets. Now imagine Merrill plugged inside of that: You have a truly diversified financial services firm, offering consumer and commercial banking alongside of retail brokerage and investment banking. We sure do hope that the ABS exposure on Merrill's books — worth about 270 percent of its tangible equity — doesn't eventually come back to bite Merrill's White Knight, Ken Lewis.
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