Holding Paulson Accountable For This Mess

As much as conservatives criticize President Obama, legitimately in my view, for federal meddling in business and dictating who should serve on the auto industry boards, we must never forget that it was Bush administration Treasury Secretary Henry Paulson who made the federal government go where it had never gone before in its dealings with private corporations. That is why the House Oversight and Government Reform Committee performed a valuable service in its hearing Thursday that got to the truth about Paulson’s threats to remove the CEO and board members of a private corporation if it didn’t do what Paulson arbitrarily deemed best for the "financial system."

Paulson exceeded his authority as Treasury Secretary on numerous occasions. When the government took over AIG in September, longtime company leader Hank Greenberg was locked out of negotiations, and Paulson replaced AIG’s CEO with Edward Liddy, whom Paulson served with on the board of Goldman Sachs when Paulson was CEO.

Reports also indicate that Paulson strongly pressured healthy banks to take government money and give the government ownership stakes in the institutions, implicitly threatening negative regulatory actions if they didn’t take the deal. A set of Paulson’s "talking points"from a meeting with bankers, obtained through a Freedom of Information request by the group Judicial Watch, has him emphasizing to bank CEOs that "if a capital infusion is not appealing, you should be aware your regulator will require it in any circumstance."

But the most disturbing allegation is the one that Paulson largely confirmed at the hearing that he, and possibly others including Federal Reserve Chairman Ben Bernanke, pressured Bank of America CEO to deceive BofA shareholders and not report the extent of losses at Merrill Lynch at the time BofA was attempting to acquire it. According to testimony before New York state Attorney General Andrew Cuomo, Lewis was seriously considering backing out of the deal, under a "Material Adverse Change"clause in the merger agreement, because of bigger losses than predicted on Merrill’s balance sheet. According to Lewis, Paulson said, "we would remove the board and management"if BofA did so. So Lewis and the BofA board backed down.

On Thursday, although he refused to call it a "threat,"Paulson admitted that he applied pressure and said that Lewis and the board could be removed. He recalled to the committee that he told Lewis that backing out of the deal, even with the new facts about the losses, would show "a colossal lack of judgment."He then told Lewis that "under such circumstances,"the Federal Reserve would be justified in removing the bank’s management.

"By referring to the Federal Reserve’s supervisory powers, I intended to deliver a strong message reinforcing the view that had been consistently expressed by the Federal Reserve, as Bank of America’s regulator, and shared by the Treasury, that it would be unthinkable for Bank of America to take this destructive action for which there was no reasonable legal basis and which would show a lack of judgment," Paulson said.

Lewis obviously failed his shareholders by not standing up to Paulson, but Paulson’s actions were the most outrageous. Paulson had no authority to remove a board and CEO of a private company – that’s for shareholders to decide.

And he can’t excuse his by saying he was merely reminding Lewis that the Fed had these powers over bank holding companies. This is a rarely invoked power, and according to the Federal Reserve’s own manual on "Supervision and Regulation,"the Fed may "remove an office or director"if "an institution has significant deficiencies or fails to comply"with the law. In this case, Paulson was arguable pressuring Lewis to break federal and state securities law by withholding material from shareholders, and to compromise BofA’s own solvency in the name of saving "the system."

Paulson’s action also cannot be excused by any counterfactual of what would have happened if the merger had not gone through. The financial crisis was largely caused by breakdown in trust, and fostering mistrust at the government level will only prolong the lack of confidence. In fact, John Taylor of Stanford University and the Hoover Institution presents empirical evidence that Paulson’s screaming Armageddon about the economy in order to get the bailout last September actually worsened the financial crisis.

Paulson and others need to be held accountable, and the rule of law must be honored. Paulson probably violated many of BofA shareholders’s constitutional rights, including the 14th Amendment’s guarantees of due process and equal protection under the law. A Bivens lawsuit, which is filed against government employees who abuse their authority and violate constitutional rights, may be appropriate for BofA shareholders to file against Paulson and others who allegedly threatened Lewis and the Board with removal they acted in shareholders’ best interests.