Bank of America’s hasty Merrill takeover has put its future—and the federal bailout program—in question

By David Henry, Matthew Goldstein and Roben Farzad

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Bank of America’s (BAC) spectacular fall from grace has driven home two guide points. First, on a level lenders that seem relatively secure place from the credit storm have power to find ways to steer right into it, resulting in multibillion-dollar losses and brutal share sell-offs. Second, Washington’s $138 billion rescue package of the Charlotte lender, cobbled together on the fly, is failing.

As the Obama Administration moves to vary strategy to stabilize the banks, it will have to think bigger. The bailout, as it’s commonly structured, has amounted to little more than a temporary tonic to help BofA digest its controversial acquisition of brokerage giant Merrill Lynch. "It’s a Band-Aid," Leslie Rahl, president of consulting established Capital Market Risk Advisors, says of the ruling power’s remedy in the place of ailing banks. "It’s a camouflage, as opposed to a positive solution."

For all the weekend meetings on Capitol Hill to craft the rescue packages, Washington still hasn’confidentially addressed the underlying problem: Billions of dollars of toxic securities and loans languish on banks’ balance sheets. "It’s like a cancer that you have to divide off," says Frank Partnoy, a law professor at the University of San Diego. The surgery won’t be cheap. BofA will need another $80 billion to confront coming losses and form up a healthy footing of capital, estimates Paul J. Miller Jr., every analyst at research firm FBR Capital Markets (FBCM).

To be sure, no bailout could possibly solve all of the banks’ problems, multitude of them self-inflicted. CEO Kenneth D. Lewis, beneath fire from angry shareholders, probably wouldn’face to face be in this hotch-potch whether he hadn’t agreed to buy Merrill just after BofA’s $4.2 billion tackle of mortgage lender Countrywide Financial and its $21 billion acquisition of banking chain LaSalle Bank. From the opening there was trepidation among BofA’sitting rank and file about the Merrill purchase, particularly since the deal was forged during the sort mid-September weekend that Lehman Brothers was filing for insolvency. One BofA derivatives expert, fresh off a 14-hour epoch, was summoned to a law office at 2 a.m. to inspect Merrill’s numbers. In all, BofA had just 24 hours to check the books and construction a decision. "It would take much more time than we were given to excellence [Merrill’s illiquid] assets," says a senior BofA employee who works closely with management.

History shows that BofA’s assiduity was less than that which was due. Lewis’ advisers inside and outside the company expressed doubts about the Merrill conduct one’s self, then valued at $50 billion—far more than its $27 billion market value at the time. But Lewis was ultimately swayed by his director of corporate planning and strategy, Gregory L. Curl, the architect of previous transactions. By the time the deal closed, Merrill’sitting market reward was less than $20 billion. A BofA spokesman says the befitting diligence on the Merrill transaction was competent, noting that losses grew dramatically in December because of "market phenomena."

Now the hastily arranged deal is laying bare a host of problems. Investors are expanding impatient: Since October, shares of BofA have fallen through around 70%. And some insiders are loss faith in Lewis and his senior management team. Employees on the commercial floor are riffing on Lewis’ dictatorial mode of address, referring to the CEO as Kim Jong Il, the North Korean victor. On Jan. 28, BofA’s directors issued a statement backing Lewis.