Merrill Lynch (MER) is gone, sold to Bank of America (BAC) for $44 billion. That is $29 a share, well below its 52-week high of $79, but above the $17 where it closed on Friday.

Merrill would have opened below $10. The schizophenia caused by the current credit crisis is that great. The brokerage may well have had a balance sheet which would have allowed it to remain independent, but the Lehman (LEH) gone, the doubt was spreading to the next company on the list and short-seller would swamp over the company like leeches.

The word is the Paulson at Treasury encouraged the deal. He did not want one more beggar at his door if the financial community wanted him to back the value of Merrill’s portfolio which was loaded with mortgage-backed securities. They have become as toxic as a Super Fund site, and their implied value would have dropped sharply when the market was flooded with Lehman’s assets the doomed company’s customers and a bankruptcy court ran a grisly auction to get whatever value was left of the failed investment bank.

The horror of the situation is that Merrill could have been credit-worth enough to stand up to the forces of panic selling of its shares. But, the company’s board knew better and took the $29 that was on the table. As fiduciaries, they did no have a choice. If Merrill had traded down to $10 at the open and then failed, they would have been viewed with the same distain as Lehman’s board and the shareholder lawsuits would have gone on forever. Selling out the firm makes its balance sheet Bank of America’s problem. With its huge deposit base it can take the risk. If the disease of the crisis rages beyond the weak securities firms and Washington Mutual (WM), even BAC could be buffeted by the market’s distress because it bothered to risk stockholder health to get a large retail broker network and an investment bank.

What is more likely is that Bank of America can take Lehman’s jewels and afford to hold on to its devalued portfolio of junk mortgage-paper until the housing market recovers and the assets increase in value. On that day Bank of America’s management will look like geniuses for rolling dice to get a company which was crippled more by market panic than its balance sheet. In an environment where the balance sheets of all the weaker companies in the industry are mistrusted, Merrill Lynch had no chance, whether that was rational or not.

John Thain, who was brought in to replace former CEO Stan O’Neal, ultimately did not better than his predecessor. To some extent, any competent financial executive would have come to the same end. In April Thain had said the worst of the mortgage problems were on the horizon. Then Merrill unexpectedly raised more money and its shareholders became rabid. They were not willing to suffer another set of losses because the company might be fixed. They knew that a promise had been broken and it undermined most confidence that something broken so badly could be rebuilt.

Merrill became a victim of the herd mentality which said that any firm which passed on the riches of mortgage-back securities would be seen as a sucker. The housing boom which was the foundation of the value of the assets was strong and getting stronger. That was true until the day when it was not.
"Earning envy" became a terrible thing. Merrill management could not afford to be viewed as buffoons for refusing to take a ride on a rocket and get its share of the yield from the economy’s impressive success. Americans are handy enough people to fix a recession within a few quarters. During that time, the downturn is merely a nuisance.

For the first time in 80 years, an inconvenience took on all the symptoms of a virulent cancer. The mental state of optimism deserted the average citizen. He could not live with the nightmare that his home, the most important piece of his portfolio, had been devalued beyond what he could have ever imagined. One homeowner who will never be identified, sold his home far below what its value had been in 2006. His neighbor saw this and sold his. The word spread among realtors that the magnificence of the housing boom was being shattered

It would be inappropriate to say that Merrill was killed by a panic attack in the market driven by the failure of some of its smaller brokerage peers. It was caused by homeowners who could not stand the sight of their houses torched by a reversal in their fortunes. That was the germ of a problem that gestated into a full-fledged weed which ate the healthy vegetation around it.

For want of a nail the kingdom was lost. Merrill was swamped by a tidal wave that began as a small ripple.One home sold followed by hundreds of thousands.

Douglas A. McIntyre

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