Issue of the week: Did the feds help hide Merrill’s losses?

“No wonder no banker in his right mind” trusts the Federal Reserve or the Treasury Department, said The Wall Street Journal in an editorial. We now have damning evidence that Fed Chairman Ben Bernanke and then–Treasury Secretary Henry Paulson “botched the bailout and made the financial crisis worse.” The smoking gun is found in newly released transcripts of a deposition that Bank of America Chairman Kenneth Lewis gave in February to New York Attorney General Andrew Cuomo. Lewis testified that last December, as BofA was preparing to finalize its government-aided acquisition of Merrill Lynch, he learned that Merrill’s financial condition was deteriorating rapidly. He tried to call off the deal, but Paulson put his foot down. Lewis testified that Paulson, saying that he was acting at Bernanke’s behest, had told him that “the feds would fire him and his board if they didn’t complete the deal.”

What’s worse, said Allan Dodds Frank in TheDailybeast.com, is that Paulson, according to Lewis, barred him from disclosing Merrill’s losses to BofA shareholders. If that testimony is accurate, then Paulson in effect strong-armed Lewis into violating U.S. laws that “require disclosure of significant financial events—such as a proposal to buy a pig in a poke—to shareholders.” That happens to be entirely in character for Paulson, who “worked in the Nixon White House for John Ehrlichman in 1972 and 1973, as the Watergate scandal unfolded.” Now, in light of Lewis’ revelations, Americans have to wonder “what other companies did Paulson et al. threaten? Which companies did Paulson force to remain silent about toxic deals?”

Why assume that Lewis is telling the truth? asked Derek Thompson in TheAtlantic.com. Bernanke has denied Lewis’ assertions (Paulson has kept mum so far). Moreover, Lewis’ self-serving testimony glides over the inconvenient fact that he was worried about “enormous impending losses from Merrill’s balance sheet” as long ago as last summer, when he first considered acquiring the brokerage house. He expressed his qualms to Bernanke and Paulson, who “sweetened the deal” by offering to shoulder some of Merrill’s losses. Then, when “Merrill’s loss emerged even worse than all sides expected, Lewis rushed to save face,” first by blaming Merrill CEO John Thain for hiding the red ink and now by smearing Paulson and Bernanke. In light of what we know, “Lewis’ shock and rage” smell awfully “fishy.”

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That’s putting it too kindly, said Barry Ritholtz in The Big Picture, a finance and economics website. Lewis’ testimony is “utter and shameless nonsense, an attempt to worm out of responsibility” for BofA’s disastrous acquisition of Merrill. If Paulson did indeed lean on Lewis to keep quiet about Merrill’s widening losses, then Lewis had a fiduciary duty to tell BofA’s shareholders about the treasury secretary’s intimidation tactics. Instead, he kept his mouth shut and saved his job. It’s just the sort of “weaselly responsibility-evading” we’ve come to expect from bank executives. Lewis survived a no-confidence vote by BofA shareholders this week. But after these latest revelations, his days are surely numbered.