Merrill Lynch Was Sold Over a Weekend to Avoid Being Next
On the same weekend Lehman failed, Merrill Lynch agreed to sell itself to Bank of America. The chief executive concluded his firm would not survive the following week.
The Weekend
During the weekend of Lehman Brothers' collapse in September 2008, Merrill Lynch agreed to be acquired by Bank of America.
Merrill was not failing that weekend in the way Lehman was. Its chief executive reportedly concluded that once Lehman failed, market attention would move immediately to the next most exposed independent investment bank, and that Merrill would face the same funding withdrawal within days.
The Reasoning
That judgment was sound and it is worth stating precisely. Merrill held substantial mortgage related exposures and funded itself in wholesale markets, the same structural position as Lehman.
In a panic, counterparties do not conduct careful comparative analysis. They reduce exposure to anything resembling what just failed. Being the next most similar institution is sufficient.
Selling from a position of weakness produces a poor price. Waiting to test whether you can survive produces no price at all if you are wrong.
Why It Was Different From Lehman
Lehman had sought a buyer and none emerged on acceptable terms without government support, which was not forthcoming. Merrill secured an agreement before the market had time to price its distress.
The timing was the whole difference. A firm negotiating before a run has a franchise, a client base, and a brand to sell. A firm negotiating during a run has assets nobody can value and a name that has become a liability.
The Disclosure Controversy
The subsequent controversy concerned what shareholders were told. Merrill's losses in the fourth quarter of 2008 proved far larger than anticipated when the deal was agreed, and the acquisition completed in January 2009.
Bank of America shareholders voted on the transaction in December. Questions arose over whether the deteriorating losses were adequately disclosed before that vote, and over whether Bank of America's leadership had considered invoking a contractual provision to withdraw and was discouraged from doing so.
Litigation and regulatory proceedings followed for years, and Bank of America subsequently required additional government support partly because of the acquired losses.
The Bonus Question
A further controversy concerned bonuses paid at Merrill for 2008, accelerated so payment occurred before the acquisition completed, at a firm that had generated enormous losses and was being absorbed with public support in the background.
That episode contributed substantially to public anger about the crisis response and to subsequent rules on compensation deferral and clawback in financial institutions.
The Bottom Line
Merrill sold because being next in line was sufficient reason, and the judgment was correct. Acting before the market prices your distress is the difference between a bad price and no price.