The Wall Street Journal (subscription required; shorter Bloomberg article here) is reporting that Bank of America will receive billions of dollars more in government aid, probably in a deal that looks something like the second Citigroup bailout, ostensibly to help absorb losses incurred by Merrill Lynch since the acquisition was negotiated in September but more generally to shore up B of A’s increasingly shaky balance sheet. At least someone involved knows how this looks: the reports say the deal will be announced on January 20 – yes, the day of Barack Obama’s inauguration – thereby keeping it from being the main story of the day.

It looks bad for all sorts of reasons:

• Wasn’t B of A supposed to be a healthy bank? Isn’t Ken Lewis (CEO) the person who told Henry Paulson he didn’t need the first round of TARP money, but he would take it to show solidarity and for the public good?
• The money is going to finance an acquisition? Isn’t that the thing that (according to most people) banks aren’t supposed to be doing with their bailout money?
• The B of A-Merrill deal closed on January 1. So it looks like – as the WSJ is reporting – the deal only closed because Treasury gave B of A a verbal commitment to supply the needed bailout money later.
• Isn’t this more policy by deal?

That said, I think some sort of deal has to be done. Even Yves Smith at naked capitalism (one of the most consistent and sharp critics of the way TARP has been implemented), who says this deal “stinks to high heaven,” says that “Merrill is a systemically important player” and “letting the deal with BofA ‘fail’ is a non-starter.” But I predict that when the terms are announced I will think they are too generous – especially since B of A now has all the negotiating power, since they closed the acquisition based on a promise from Treasury.

To recap – because I have this pathological fear of not being understood – I think that TARP’s primary purpose is to protect the financial system against the collapse of any systemically critical financial institutions (I leave it to others to define what those are, but Bank of America definitely is one, GMAC I’m skeptical about), and it has suffered from three main problems:

1. The initial round was too small, with banks only getting 3% of assets or $25 billion, whichever was smaller – which is why Citi and now B of A have had to come back.
2. The terms were too generous; I can make an exception for the first round, but I don’t understand why Citigroup 2 and GMAC were so favorable to shareholders.
3. Except for the very generous initial round, it’s just a pile of money to be used in ad hoc deals, not a comprehensive program with a coherent strategy, so no one is quite sure how or if it will be able to protect the financial system.

The B of A bailout will only sour public and Congressional opinion further against TARP, making it less likely that the second $350 billion will ever be released, and more likely that if it is released it will be packaged with all sorts of conditions (not necessarily bad) or allocated to community banks (beside the point).

It is true that one price we are paying in these bailouts is the creation of a new tier of mega-banks that, because they are Too Big To Fail, have the competitive advantage of being essentially government-guaranteed. What we really need as a condition on TARP money is a new regulatory structure to make sure that these mega-banks do not abuse the oligopolistic position we have just handed them, and perhaps a commitment to break them up when economic circumstances allow. That would be considerably more valuable than a cap on executive salaries and corporate jets. But it will also be a lot more difficult to define and to agree on.