Paulson stands by BofA-Merrill deal

Former Treasury chief tells House panel why he worked to save controversial shotgun marriage on Wall Street.

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By Jennifer Liberto, CNNMoney.com senior writer

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WASHINGTON (CNNMoney.com) -- Former Treasury Secretary Henry Paulson, testifying before Congress for the first time since leaving office, defended his role Thursday in salvaging a controversial deal struck during the height of the banking panic last fall.

Lawmakers grilled Paulson about whether he overstepped his authority in pushing for Bank of America to follow through on its takeover of Merrill Lynch, a deal that cost taxpayers billions.

Paulson testified before the House Committee on Oversight and Government Reform, whose members have already questioned the chiefs of Bank of America (BAC, Fortune 500) and the Federal Reserve.

Last September, Bank of America's purchase of Merrill Lynch was trumpeted as good news -- an example of the financial sector saving its own -- especially when compared to the near-simultaneous bankruptcy of Lehman Brothers.

Yet, the BofA-Merrill deal later nearly collapsed and was rescued by billions of taxpayer dollars and government intervention, the full extent of which had not fully surfaced until officials started investigating earlier this year. The House Oversight hearings aim to get to the bottom of the government's role in salvaging the deal.

Paulson added clarity to a few big questions looming over the merger. He made clear that he threatened Bank of America's chief with replacing the bank's management if they didn't go through with the deal.

He also said he didn't keep the Securities and Exchange Commission in the loop during December negotiations with the financial firms, saying that wasn't his "responsibility."

Paulson said he saw it as his role to do what he could to save the merger after it started to come undone, because regulators feared such a failure would cause the markets to question the stability both Bank of America, Merrill Lynch and even the entire financial system.

"I believe it was the view of the government that when these losses were announced, they would truly shake the market if it were not for some sort of government support in place," Paulson said.

The panel's chairman, Rep. Edolphus Towns, D-N.Y., has said he is most interested in uncovering what turned Bank of America's acquisition of Merrill Lynch from a "private business deal" into one that hinged on another $20 billion bailout.

Towns said that federal regulators, including Paulson, "got what they wanted out of this marriage."

"They got an uninterrupted merger that they believed help stabilize the markets," Towns said. "The problem is that all along the American people, the investors, and the Congress were kept in the dark. In my view , this is unacceptable and must be prevented from happening in the future."

Republicans tended to hammer on the notion that regulators bullied companies into the bailout and cloaked their actions.

"I think it shines a light on where we're headed ... so it's important we see what happens when we give this kind of involvement to the federal government," said Rep. Jim Jordan, R-Ohio.

What happened last winter?

The House panel's questions about the BofA-Merrill deal stem from separate probes by the New York Attorney General's Office and the Special Inspector General for the Troubled Asset Relief Program, the $700 billion bailout program enacted last October.

In December, Bank of America CEO Kenneth Lewis approached regulators, including Paulson and Fed Chairman Ben Bernanke, and threatened to scuttle the acquisition after discovering the scope of Merrill's losses, according to records released by New York Attorney General Andrew Cuomo.

In his prepared testimony, Paulson said he believed that the economy, the financial markets and firms were "fragile" at that point. He was worried that there wasn't enough money in the federal bailout program to "respond to the financial chaos" to result from the collapse of the BofA-Merrill deal.

He also wrote that he and other regulators believed that if the deal failed, the markets would question the health of BofA and put the bank's shareholders and the nation's financial system at risk.

After behind-the-scenes wrangling, BofA received $20 billion in aid in January on top of $25 billion it received last fall as part of TARP.

The bank also got loss guarantees on $118 billion in assets to help the company absorb its purchase.

Paulson defended the extra bailout funding, saying he had made it clear since October that the government would act to prevent failure of systemically important firms.

"It was clear that if the merger proceeded, and the combined Bank of America-Merrill Lynch entity needed financial support, the government would work to provide such appropriate and necessary support," Paulson said in his prepared remarks.

Last month, when testifying before the House panel, Bernanke denied accusations that he threatened to replace Bank of America managers if they didn't go through with the purchase of Merrill.

Lewis told lawmakers that he felt pressure to go through with the acquisition.

E-mails among Fed officials that came to light last month suggested that Lewis may have used the threat of scuttling the Merrill deal as a so-called bargaining chip for more government assistance.

But Paulson explained that threats of replacing management weren't merely intended to push the company into going through with the deal. He stressed that BofA's withdrawal would show a "colossal lack of judgment" and jeopardize the companies and the financial system, giving the Fed the right to use its power to replace management.

"I was attempting to send a very strong message to Ken Lewis in terms of how strongly the Fed and Treasury viewed this matter," he said during the hearing.

Paulson was asked why he didn't alert the SEC to his talks with Bank of America in December if he was worried about its financial stability if it pulled out of the merger. Paulson said that wasn't his job.

"That's not my responsibility; that's the role of Bank of America to work with the SEC," he said.

Another point on which Paulson was hammered was whether he suggested the bank not disclose that government assistance was coming.

Paulson's answers were unclear. He said he never ordered the bank not to disclose it. But he also acknowledged that he didn't want the promise of additional government support in writing, because the understanding lacked major details, such as how much money would be given.

"We had nothing specific to put forward," he said. However, Paulson also said that if the promise of more bailout dollars had been put in writing, he would have pushed for its disclosure. To top of page

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