Low-Frequency High Consequence Event. ERM IST625 Assignment.

1. Where are they Now? (IST 625) Jash Mohinish Mehta
Where are they now?
Merrill Lynch is the wealth management division of Bank of America. ("Home," n.d.)
Merill Lynch is a company in Financial Services it was founded in 1914. Currently, it is
headquartered in New York City at Four World Financial Center. Merill Lynch covers
worldwide investment management. It employs 15,100 Financial Advisors as of 2010.
A bit History about the company:
Charles E. Merill founded a company called Charles E. Merrill & Co. on January 6, 1914.
A few months later, Merrill's friend, Edmund C. Lynch, joined him, and in May they open
an office at 7 Wall Street in downtown Manhattan. In 1915 the name was officially
changed to Merrill, Lynch & Co. ("TIMELINE: History of Merrill Lynch| Reuters," n.d.)
The Low Frequency-High Consequence Event:
How Merill Lynch and other banks created this event?
The Low Frequency-High Consequence Event is the collapse of Housing Market in the
USA in 2008. It was believed by the experts that the housing market in the USA would
never come down and the prices of houses of different states are independent of each
other. However, in 2006-2008 the housing market failed in the USA and it created a
phenomenon called as Frozen Credit. This event affected all the major banks including
Merill Lynch.
After the period of Dotcom bubble, started a phenomenon called as Housing Bubble in
the USA. In this bubble the stakeholders involved were houses owners, investors,
lenders, banks.
Basically, the home owners are the people who take mortgages to buy homes. These
mortgages are held by lenders. The lenders further sell this mortgages to investment
banks. The investment banks creates a pool of mortgages and slices them according to
the risks involved in the investment. These slices are then further sold to investors. ("Crisis
of Credit Visualized - HD," n.d.)
Prior to the Housing Bubble the investors in the USA used to invest into Federal Reserve.
They used to buy treasury bills which used to give a decent return at that point of time.
However, at the bust of Dotcom bubble and after September 11 terrorist attack on World
Trade Center, Federal Reserve Chairman Alan Greenspan lowered interest rate to only
1% to keep the economy strong. This 1% return was too low for the investors and they
started looking for other investment opportunities. On the other side the banks on the Wall
Street started borrowing huge sum of money from the Federal Reserve as the interest
rate was pretty low. This rampant borrowing caused the bank to take more risks which
gave rise to Subprime Mortgage Crisis in the United States. ("Crisis of Credit Visualized - HD," n.d.)

2. Where are they Now? (IST 625) Jash Mohinish Mehta
Since banks started taking more risks they also got good returns. This was seen as an
opportunity by the investors to invest in the products offered by the banks. This gave rise
to new market, the banks could sell the mortgages to the investors.
A family in USA would generally save for a down payment, then the family would take a
mortgage for the house against that down payment. The housing prices had been rising
practically forever so it was a nice deal for the family at that moment.
The mortgage of this family is sold by the lender to an investment bank. The investment
bank borrows money from the Federal Reserve and buys more of these mortgages. This
means that the investment banks gets payments from all the mortgages it had bought
from the lender. The investment banks held to theses mortgages for a short term. The
investment banks bundled these mortgages called as CDOs (Collateralized Debt
Obligation). The CDOs were divided according to the risk of the investment and the
divisions were rated by a credit rating agency. The least risky investments were rated as
AAA. To make these investments safer the banks insured the AAA investment for a small
amount called as CDS (Credit Default Swaps). ("Crisis of Credit Visualized - HD," n.d.)
This whole process created more demand among the investors to invest in the CDOs. At
one point of time when there were fewer families who wanted mortgages. The investment
banks at Wall Street and lenders saw subprime mortgages as a tool for creating altogether
a new market. Subprime Mortgages were the mortgages which didn’t require any down
payment and any proof of income from the families. Basically, a low income family which
didn’t qualify for the loans earlier were now qualified for the subprime mortgage. This is
believed to be the turning point in the period of Housing Bubble. ("Crisis of Credit Visualized - HD,"
n.d.)
The subprime mortgage also follows the same process of CDOs, CDS & AAA ratings.
Eventually, these CDOs are bought by the investors. Since these were the Subprime
Mortgages, the families holding them started defaulting on the payments. Slowly, due to
the defaulting of the payments the house prices in the USA started falling. It is also
coupled with the increase in the interest rate which caused the variable rate mortgages
to pay more. These caused more supply of houses in the market than the demand and
the house prices are not rising anymore. At this point of time the investors, the banks, the
lenders are holding on to CDOs and mortgages worth billions. The losses were beyond
imagination. The consequence of this “low frequency- high consequence” was a
phenomenon called as Global Recession. ("Crisis of Credit Visualized - HD," n.d.)
Losses:
 Merill Lynch lost $7.9 billion as liabilities and wrote off $9 billion in holdings.
(sevenpillarsinstitute, n.d.)
 John Thain was the new CEO. The new leadership did not help much.

3. Where are they Now? (IST 625) Jash Mohinish Mehta
 There were further losses of $10 billion in CDOs in 2008, the bank was then in
serious trouble. (sevenpillarsinstitute, n.d.)
 Merill Lynch as any other bank at that time had no contingency plan. It was so
deep in debt and losses that the only contingency plan it had got is to sell their
company and assets to some other company.
Emergency Response:
“Thain approached Bank of America CEO Lewis to sell the company. Although Thain
initially turned down the offer from Lewis, Thain only wanted to give Bank of America 10%
of the stake to save Merill Lynch. However, he sold Merrill Lynch for $50 billion, at $29
per share. Merill Lynch had more than $1.02 trillion in assets and more than 60,000
employees worldwide. Bank of America became more universal once it acquired Merrill
Lynch. The primary concern for Bank of America was the actual worth of Merrill Lynch in
2008, when the market environment fluctuated rapidly. Lewis wanted to buy the company
because of Merrill Lynch’s strongest unit, its 16,000 investment advisors, which would fill
a hole in Bank of America’s product offering. The entire take-over took place in the panic
when Lehman Brothers was about to declare bankruptcy.” (sevenpillarsinstitute, n.d.)
Involvement of Technology:
I did not find any article in my research stating that there was technology involved for
eliminating any kind of risk. Neither technology played any part in the losses accrued by
Merill Lynch.
The short-term consequences:
1) When the entire financial system was failing and when Lehman Brothers was about
to file its bankruptcy, the executive management approached Bank of America.
They wanted to sell its assets for 10% of the stakes. However, Bank of America
wanted to buy Merrill Lynch outright.
2) The overall American economy would be adversely impacted if the deal didn’t go
through.
3) On the other hand, if the deal went through, the shareholders would take a blow in
terms of diluted share value. It was estimated that it would take 2-3 years for the
deal to bring strong economic value to the company.
The long-term impacts were more difficult to predict:
1) Letting Merrill Lynch fail would result in a total collapse.
2) On the other hand, allowing the market to take its natural path would be in the best
interest of the public and the shareholders.

4. Where are they Now? (IST 625) Jash Mohinish Mehta
3) There was a massive hit in the financial industry after the fall of Lehman Brothers.
If the deal did not go through and Merrill Lynch was declared bankrupt, it would
have created more mess in the financial industry.
4) The firm recovered in the long term due to the relief packages given by U.S
Government in 2009. This is explained in “What helped them the most in their
recovery efforts?” below.
Biggest Challenges in the takeover:
For the fourth quarter Merill Lynch showed loss in December 2008. Therefore, Bank of
America was having second thoughts of acquiring Merill Lynch. There were a series of
meetings and discussions among Bank of America, the regulatory agencies, and
Treasury. During these discussions, Ken Lewis, told that the company was considering
invoking the Material Adverse Event clause in the acquisition contract, known as the
MAC, in an attempt to rescind its agreement to acquire Merrill Lynch.
Chairman Ben S. Bernanke expressed concern that invoking the MAC would have
significant risks, not only for the financial system as a whole but also for Bank of America
itself, for three reasons.
1) Due to extreme fragility in the financial system, invoking the MAC would have
triggered a broader system risk that could have destabilized Bank of America as
well as Merill Lynch.
2) Any attempt to invoke the MAC would create doubts in the minds of financial
market participants.
3) Chairman Ben S. Bernanke believed that it was highly unlikely that Bank of
America would be successful in terminating the contract by invoking the MAC.
What helped them the most in their recovery efforts?
The Troubled Asset Relief Program (TARP) played a key role in stabilizing the financial
system during the merger phase. Bank of America received $20 billion from the U.S
government through the TARP and this was an addition to the $25 billion given to them
in the Fall 2008 through TARP. According to a March 15, 2009, article in The New York
Times, Bank of America received an additional $5.2 billion in government bailout
money, channeled through American International Group. ("U.S. pushed Bank of America to complete
Merrill buy: report| Reuters," n.d.)
Bank of America's Ken Lewis said during the announcement, "We appreciate the critical

5. Where are they Now? (IST 625) Jash Mohinish Mehta
role that the U.S. government played last fall in helping to stabilize financial markets,
and we are pleased to be able to fully repay the investment, with interest.... As
America's largest bank, we have a responsibility to make good on the taxpayers'
investment, and our record shows that we have been able to fulfill that commitment
while continuing to lend." ("Bank of America to Repay Entire $45 Billion in TARP to U.S. Taxpayers," n.d.)
Outcomes:
Due to the acquisition of Merill Lynch there was little instability in the initial stage as there
was a diluted share holder value. But this merger made Bank of America the world’s
largest wealth management Corporation and a major player in the investment banking
market.
In my research I could not find how it affected culturally or socially to Merill Lynch.
However, Bank of America’s acquisition of Merrill Lynch made it the world's largest wealth
management corporation and a major player in the investment banking market.
The company held 12.2% of all bank deposits in the United States in August 2009, and
was one of the Big Four banks in the United States, along with Citigroup, JPMorgan
Chase and Wells Fargo—its main competitors. ("BofA Plans to Cut 10% of Branches - WSJ," n.d.)
Lessons Learned:
 The whole financial industry including Merrill Lynch was taking careless risks.
 The risks they were playing with were: Credit Risks, Market Risks, Liquidity Risks.
 They had no contingency planning and had no way to come out of the disaster.
 There were no federal regulations at that point of time which prevented these
investment banks from taking more risks.
The whole financial industry had this culture to take more risks in order to gain more
returns. There was no risk identification process done neither by the banks nor by the
regulators. In addition to that in spite of warnings and signs of danger from the experts
globally the banks and government took no action to curb the risks. Rather, there were
more risks taken by lending subprime mortgages. Eventually, they had no contingency
planning for a disaster such as 2008.

6. Where are they Now? (IST 625) Jash Mohinish Mehta
References
4 Major Banks Tap Fed for Financing - The New York Times. (n.d.). Retrieved from
http://www.nytimes.com/2007/08/23/business/23discount.html
Retrieved from http://sevenpillarsinstitute.org/case-studies/bank-of-americas-takeover-of-
merrill-lynch
A.I.G. Lists Banks It Paid With U.S. Bailout Funds - NYTimes.com. (n.d.). Retrieved from
http://www.nytimes.com/2009/03/16/business/16rescue.html?ref=business
Bank of America to Repay Entire $45 Billion in TARP to U.S. Taxpayers. (n.d.). Retrieved
from http://www.prnewswire.com/news-releases/bank-of-america-to-repay-entire-45-
billion-in-tarp-to-us-taxpayers-78355327.html
BofA Plans to Cut 10% of Branches - WSJ. (n.d.). Retrieved from
http://www.wsj.com/articles/SB124874668619485699
Citigroup posts 4th straight loss; Merrill loss widens - USATODAY.com. (n.d.). Retrieved from
http://usatoday30.usatoday.com/money/companies/earnings/2008-10-16-
citigroup_N.htm
The Crisis of Credit Visualized - HD. (n.d.). Retrieved from
https://www.youtube.com/watch?v=bx_LWm6_6tA
FRB: Testimony--Bernanke, Acquisition of Merrill Lynch by Bank of America--June 25, 2009.
(n.d.). Retrieved from
http://www.federalreserve.gov/newsevents/testimony/bernanke20090625a.htm
Home. (n.d.). Retrieved from http://individual.ml.com/index.asp?id=15261_15423
TIMELINE: History of Merrill Lynch| Reuters. (n.d.). Retrieved from
http://www.reuters.com/article/us-merrill-idUSN1546989520080915

7. Where are they Now? (IST 625) Jash Mohinish Mehta
U.S. pushed Bank of America to complete Merrill buy: report| Reuters. (n.d.). Retrieved from
http://uk.reuters.com/article/us-bankamerica-treasury-idUKTRE5140OA20090205