Treasury to Bank of America: You've Got Mail

In December 2008, Merrill Lynch & Co. (ML) was on the verge of bankruptcy.  Bank of America (BA) was the Treasury's last remaining viable buyer.  As the negotiations to acquire ML proceeded, additional information about Merrill's potential losses spooked BA CEO Kenneth Lewis, who suggested to Secretary of Treasury Paulson that they were going to exercise a material adverse clause in the merger agreement to end negotiations.  Paulson and Federal Reserve Chairman Bernanke pressured Lewis to go forward with the deal and he capitulated.  Craig Torres and Scott Lanman of Bloomberg tell the story more fully in, "Fed Memo Said Aid for Bank of America Would ‘Come at a Price’" (June 11, 2009).

Jessica Pressler a New Yorker writer gives sage advise in "Fed Flamed Bank of America CEO in E-mails, Threatened to Have Him Fired" (June 11, 2009).

See, this is why we always say that if you're going to threaten someone you should do it in person, in an area that has been swept clean of recording devices. What is even the point of working for the United States government if you cannot take advantage of the CIA's infrastructure for this stuff? The full e-mails have not been released yet, but we imagine when Bernanke's whole "Don't you know who I AM? You and me, we’re f*****’ DONE professionally" rant hits the Internet he's going to be mighty embarrassed.

The Bush administration professed love for markets until the financial meltdown began in September, 2008, when President Bush proclaimed "I've abandoned free-market principles to save the free-market system."[1]  The negotiations between the Treasury and BA illustrate that the Bush administration was willing to run roughshod over private property rights to obtain its objectives. Motivation for Bernanke's actions may be found in his American Economic Review paper, "Bankruptcy, Liquidity, and Recession, (Vol. 71, No. 2, May 1981).  Bernanke begins his paper,

This paper examines the possibility that the economy-wide level of bankruptcy risk plays a structural role in the propagation of recessions.  The argument is as follows: Bankruptcy imposes net social costs, so that all agents have an interest in avoiding it.  Consumers and firms do this by being careful to retain sufficient liquid assets to meet fixed expenses; banks and other lenders, by being selective in choosing borrowers and limiting the size of loans.  The onset of recession strains the system by reducing the flow of income available to meet current obligations and by increasing uncertainty about future liquidity needs.  There is a general attempt to insure solvency which leads to a reduced demand for consumer and producer durables--which may in turn generate further income reductions. 

Bernanke's confidence in this model as Fed chairman exceeds his confidence as a researcher.  Near the end of the paper, he describes evidence supporting his model.

At present the empirical evidence relevant to the story I have told is limited and does not permit firm conclusions. 

The coerced purchase of ML by BA illustrates the sad nature of political commitment to markets.  Republicans often profess their love of markets in good times, but abandon them as soon as a crisis occurs with little or no evidence that the government will perform better.  Democrats are generally more skeptical of markets, but lack political support for increased intervention in good times.  But when a crisis comes, with religious fervor, Democrats "never let a serious crisis go to waste."  The result is that crisis often results in more government regardless of the party in power as Robert Higgs hypothesized in "Crisis and Leviathan,"   (Oxford University Press 1987).[2]

If anything, the Obama administration has less respect for private decision making than the Bush administration.

[1] Don Boudreaux of Cafe Hayek wrote the "Politicians Principles,"

I wrote the following lines in a private letter to friends back in December when George W. Bush, then still president of the executive branch of the U.S. national government, announced that he was abandoning his free-market principles.  The truth of these lines, however, transcends time and political party.

The man who never cheats on his wife because no other woman will have him is not particularly principled - but he proudly fancies himself that way. So the first bimbo he sniffs who'll do him the honor will prompt him to "abandon his principles" with as much alacrity as a hungry dog will attack a ham. Such are the principles of our "leaders."

(P.S. One cannot abandon what one never possessed.)

[2]  Beginning in the late 1970's and continuing until the 1990's economic crisis induced government officials to deregulate and privatize.  Perhaps Higgs' hypothesis should be amended to read that "crisis causes government action."