Towards the end of last year, Bank of America, apparently seeing a depressed valuation for Merrill Lynch and lusting after their considerable retail distribution network, agreed to purchase the firm.  According to BofA’s CEO Ken Lewis, though, there was more to the story, as he now tells the NY Attorney General that he was pressured into the deal by then Treasury Secretary Paulson and current Fed Chair Bernanke.

This may seem completely plausible - remember that the Federales got the big banks together at a low point in the current crisis and told them they were all going to hang together instead of separately - and take various amounts of TARP money.  However, CEO Lewis’ defense sounds peculiarly like someone trying to find an excuse for a bad transaction and an attempt to keep his job. 

We do firmly believe that the current lack of independence between the Fed and the Treasury is troubling and should (probably will) be addressed by Congress at a later date.  However, blaming them at this stage for a seriously poor investment decision is much like comedian Flip Wilson’s lament as the irrepressible Geraldine, "The devil made me do it."

The ’story behind the story’ on this could very well go back to the soon to be unveiled and, probably misnamed, stress tests of major US banks.  Undoubtedly CEO Lewis knows how the venerable BofA will look and he realizes that the upshot may be that he will have to fall on his sword, as well as see any legacy trashed, in order to avoid complete loss of shareholder value.

Perhaps Mr. Lewis could take heart in another of Mr. Wilson’s sayings, "You can’t expect to hit the jackpot if  you don’t put a few nickels in the machine."  Alas, Mr. Lewis played more than BofA could reasonably afford to lose.

Put this one in the ‘Ripley’s Believe it Or Not’ file. 

Apparently at the March NAIC meeting the SVO Initiatives Working Group was charged with examining how the Securities Valuation Office could be expanded into a nonprofit ratings agency.  OK, stop reading and go back and read that last sentence again.

Could the SVO become a true rating agency?  Can you teach fish to swim? 

Everyone knows that simply using the credit ratings published by the existing NRSROs for bonds, etc, has been a huge problem….and that the NRSRO economic model MUST change either by market forces or fiat.  That’s why we are constantly asking investment managers for their independent assessment of credit.

However, the SVO as a guide for credit ratings?  Virtually everyone on the investment side of the insurance industry knows the SVO is ill-staffed and too poorly organized to consider performing such a function, and that its main function is largely to serve as a security blanket for regulators.

Is this just another way for the NAIC to find job justification as the heavy hand of federal regulation descends upon the insurance industry in some form?  Probably, and we have already seen it elsewhere, as the NAIC starts to reconsider the Model Investment Law.

Meanwhile, the Rating Agency Working Group was charged with examining the reliance on ratings from Nationally Recognized Statistical Rating Organizations (NRSRO) by the NAIC and insurers.  This has the potential to move insurers from being able to use the provisionally exempt (PE) designation for ratings, and go back to the "kaching-kaching" of paying the SVO for merely referencing a translation table.

As tennis great John McEnroe yelled at many a regulator (umpire), "You Can’t Be Serious!"  Alas, in this case, the NAIC, worried like crazy over Federal involvement, is undoubtedly very serious.  Mr. Ripley may have to open a new wing at the museum.

That seems to be the message from the respected Economic Cycle Research Institute, whose weekly index of leading indicators has started turning up and seems to be staying above cycle lows during Q4.   Economic activity in the US does seem to be contracting at a lesser rate and this is telling us that light at the end of the tunnel may not be an oncoming train.

As the Federales continue their quest to become the largest hedge fund in the world, leading the greatest Re-Leveraging in the History of the World, recovery will get here eventually.   However, there remain questions about the medium and longer term impact of this Re-Leveraging, including the eventual rise of inflation and over-regulation…

On the accounting front, expect the theme of less worse to continue as new FASB pronouncements will allow banks to create capital (via retained earnings) out of what some may call ‘thin air’.  Combine positions on OTTI and FMV with the ability to restate historical ‘non-credit related’ OTTI losses from retained earnings to accumulated Other Comprehensive Income and regulatory capital rises (while total shareholders’ equity stays unchanged).  When the FASB caves in, it does so big time…and one would expect international accounting standards - where they have not done so - to follow suit.   More fuel for ‘less worse’.

And as we all see and hear, at this ‘less worse’ period, there are always fascinating commentaries going around.  Perhaps one of the most interesting was a former bank regulator who called the Federales’ bank stress tests a sham, designed to fool the American people.  This could very well be true, but stress test impacts might easily be offset by accounting and related machinations.

It reminds me of the punchline to the old joke about the guy trying to find a new accountant.

"How much is 2+2?," asks the client.

"What do you want it to be?" replies the accountant. 

"You’re hired!"