June 25 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke defended the central bank against lawmakers’ charges it put undue pressure on Bank of America Corp. to take over Merrill Lynch & Co. last year at the height of the financial crisis.

“The Federal Reserve acted with the highest integrity throughout its discussions,” Bernanke said today in testimony to the House Oversight Committee. He said actions by the Fed and other central banks last year helped avert a financial meltdown that would have produced a “Depression-like environment.”

Legislators are trying to determine whether Bernanke overstepped his authority in pressuring Bank of America to complete the purchase of Merrill. Bernanke’s record on the issue and lawmakers’ reactions may also figure in whether he will be reappointed by President Barack Obama, and in debates on overhauling the Fed’s powers and responsibility.

“These are the kind of questions that need to be answered before the president makes his decision,” Elijah Cummings, a Maryland Democrat and member of the committee, said in a Bloomberg Television interview earlier today.

Bank of America Chief Executive Officer Kenneth Lewis told the committee earlier this month that he decided to proceed with the takeover of Merrill after regulators said they might remove management and because his company’s future was “intertwined” with Merrill’s fate.

Lewis Testimony

Completing the purchase of New York-based Merrill was in the best interests of the bank, Lewis also said June 11. He cited the potential benefits to the company, as well as consequences for the bank if the deal was scuttled and the financial system was disrupted.

Republican lawmakers who have consistently opposed government rescues of financial companies have accused the central bank of overstepping its authority in pressuring Bank of America to absorb Merrill Lynch.

Republican congressional staff wrote in a memo on documents received by the House panel from the Fed through a subpoena that a “gun placed to the head of Bank of America” forced the Charlotte, North Carolina-based bank to go through with the merger, which was announced in mid-September.

Issa’s Charges

Representative Darrell Issa, the ranking Republican on the panel who voted against the $700 billion financial-rescue program last year, also said the Fed withheld concerns about the deal from other agencies.

Issa said in opening remarks that he questions “the appropriateness” of Fed actions which “ought to be a note of caution to those who want to dramatically increase its power and authority.”

Bernanke said today he didn’t threaten Lewis that he’d be fired if the bank withdrew from the Merrill deal. He said the takeover came at a time of “extreme stress in financial markets,” and noted the government had taken extraordinary steps to prevent the collapse of systemically important firms, including Citigroup Inc., Fannie Mae, Freddie Mac and American International Group Inc.

Bernanke said in the testimony that the Fed didn’t try to limit public disclosures or force the merger. He said in answering questions that he also “personally” informed Federal Deposit Insurance Corp. Chairman Sheila Bair and Comptroller of the Currency John Dugan about the Bank of America situation.

“I did not play a role in arranging this transaction and no Federal Reserve assistance was promised or provided” when the acquisition was announced on Sept. 15, Bernanke said.

Merrill Losses

Bank of America in December considered retreating from the Merrill deal because of large losses at the brokerage firm. Merrill reported a $15.8 billion loss during the fourth quarter.

The Fed chairman said if the deal fell through it “might have triggered a broader systemic crisis” that could have enveloped both Bank of America and Merrill.

Also, Bank of America might have raised questions about its risk-management and due diligence by citing rising losses at Merrill as a reason for withdrawing from the deal after three months of preparation, Bernanke said. Moreover, use of the so- called MAC clause could provoke “extended and costly litigation,” he said.

“The decision to go forward with the merger rightly remained in the hands of Bank of America’s board and management, and they were obligated to make the choice they believed was in the best interest of their shareholders and company,” Bernanke said. The Fed’s actions “have strengthened both companies while enhancing the stability of the financial markets and protecting the taxpayers,” he said.

Bernanke Defense

The Fed chairman said neither he nor any member of the Fed “instructed, or advised Bank of America to withhold from public disclosure any information relating to Merrill Lynch, including its losses, compensation packages or bonuses, or any other related matter.”

The disclosures “belong squarely with the company, and the Federal Reserve did not interfere in the company’s disclosure decisions,” he said.

Bernanke didn’t comment on the outlook for the economy or monetary policy in his prepared statement. During the hearing, the Fed announced that it will let one of its emergency programs expire and trim two others in a sign that improving financial markets allow a first step toward ending its unprecedented interventions.

New Blueprint

The Obama administration released a blueprint last week for overhauling regulation that would give the Fed more authority to supervise and regulate large financial holding companies that may pose a risk to the financial system. The plan also proposes stripping the central bank of some consumer protection powers and curbing its independence in providing emergency loans to non-bank corporations.

Bernanke characterized the Treasury’s regulatory plan as a change in approach, not an increase in power. He also made an appeal to keep consumer protection powers within the Fed and said the central bank would focus more on protecting consumers.

“The Federal Reserve was late to invoke those consumer protection powers,” Bernanke said in response to a question from Representative Paul Kanjorski, a Pennsylvania Democrat. “It is very important if the Fed retains those powers that we strengthen their priority.”

Independence ‘Critical’

When asked about legislation that would allow for broad audits of the Fed by the Government Accountability Office, Bernanke said such powers would compromise the central bank’s independence and be “highly destructive to the stability of the financial system, the dollar and our national economic situation.” Maintaining independence on monetary policy is “critical,” he said.

The central aim of financial regulatory reform should be to increase supervision of firms that are so big that they would require taxpayer-funded safety nets should they fail, Bernanke said. When asked if large banks should be broken up, Bernanke said Congress has two options as it considers legislation.

“One is to allow large banks, but to take steps that will protect the economy if in fact one comes to the brink of failure,” an approach currently proposed by Treasury, Bernanke said. “The other possibility is to restrict the size of banks. I think it is legitimate to discuss both options.”

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net; Craig Torres in Washington at ctorres3@bloomberg.net

Last Updated: June 25, 2009 14:22 EDT