Record Loss, Mortgage Crisis Spur Merrill CEO’s Exit
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GWEN IFILL: Now, the troubled mortgage market claims its biggest corporate victim to date. Jeffrey Brown has that.
JEFFREY BROWN: Last week, Merrill Lynch CEO Stanley O’Neal announced that the hit his firm has taken from the so-called subprime mortgage crisis was far greater than previously thought, about $8 billion in the third quarter of this year. Today, the world’s largest brokerage firm followed up with a new announcement: O’Neal himself was out.
We look at this ousting and other fallout with Roben Farzad, Wall Street and markets editor for BusinessWeek magazine, and Samuel Hayes, professor emeritus of investment banking at Harvard Business School.
Roben Farzad, just a few weeks ago, Stanley O’Neal had talked of big losses and then suddenly they were huge losses. What happened?
ROBEN FARZAD, Editor, BusinessWeek: It illustrates just how deeply this housing market has declined and even blindsided people on Wall Street. The firm really blindsided the street earlier this week by announcing its largest quarterly loss in history. And Stanley O’Neal largely fell on his sword, and he said, “I’m responsible,” but unfortunately when your stock is down 33 percent, and the troops are very worried about further upcoming losses, they were out for blood. And in short order, they ousted him.
JEFFREY BROWN: Professor Hayes, how do you not know that you’re losing that much money?
SAMUEL HAYES, Harvard Business School: Well, you don’t know if your own people who are specialists in the area don’t know. And those people, who were the investment bankers and the traders, who were running the collateralized debt obligation part of the business, didn’t know themselves.
JEFFREY BROWN: Tell us a little bit more, staying with you. These are clearly very risky investments, but make the connection for us from the mortgage lending crisis to the losses at Merrill Lynch?
SAMUEL HAYES: Well, they had been the number-one underwriter of these kinds of new issues of derivative securities for almost two years and had realized huge profits in the form of fees that they got for being the number-one underwriter, some $800 million.
And in the course of selling these underwritten issues, they still had a good bit of inventory of some of the securities they couldn’t sell easily, so they had them in their inventory. They had over $30 billion in their inventory.
And since these things don’t trade very often, it’s hard to get a really good price on them. And when they finally did get prices, they found that the securities weren’t worth $30 billion; they were worth closer to $20 billion. So that was the process.
O'Neal's responsibility for losses
JEFFREY BROWN: So, Roben Farzad, you're saying that Stanley O'Neal fell on his sword. Is he the one that made the bets, or is he taking the responsibility for making the bets?
ROBEN FARZAD: No, of course not. But under his leadership, I mean, he's been there for five years. And he took over the helm at Merrill Lynch, if you want to talk about this cyclically, when it was recovering from the WorldCom and Enron sagas and the Internet bust, and they needed a cleanup guy. And he was very much that antiseptic cleanup guy.
But then when the market got its life back, he wanted to breathe more mojo into it and encourage the troops at Merrill to really binge on this subprime mortgage boom. I mean, all of Wall Street was feeding at that trough. And that's great when it works, and the market is liquid, and the housing market is going up, and it recourses up and down Wall Street to Main Street.
But on the way down, it hurts. Wall Street is done with that binging phase, and now it's firmly in its purging phase. If you look at the other players on the street, Bear Stearns has taken a hit. Citigroup has taken a hit. UBS had to oust its CEO. It seems like an epidemic across the street, but it happens every five or six years.
O'Neal's personal history
JEFFREY BROWN: Let me stay with you a moment. Tell us a little bit about Mr. O'Neal himself, because he has a very compelling personal story.
ROBEN FARZAD: Well, biographically, he'll go down as the highest-ranking African-American in Wall Street's history. Merrill Lynch is 93 years old. It's historically been the province of blue-blooded white shoe investment bankers. You know, decades ago, it opened up to Catholic people and Jews.
And Stanley O'Neal really broke through that color barrier in 2002, in becoming CEO of the largest brokerage firm in the world. He is two generations removed from slavery, really an incredible biography, lifted himself up from the bootstraps from a childhood in the Deep South, went to Harvard Business School. I don't know if Professor Hayes had him, but really graduated upwards in Merrill Lynch.
And as an insider, he didn't have to be a back-slapping insider, really became the right guy at the right time in 2002. And it's a testament, I think, to his legacy, not to apologize for him, that you've hardly discussed race. It hasn't been bandied about that much this week. He came in on his merits and he came out on his merits. And I think that will be a big part of his legacy.
JEFFREY BROWN: Professor Hayes, did you have him as a student? Or did you know him? What can you tell us?
SAMUEL HAYES: No, I didn't have him, and I didn't know him, but I've always had a high regard for him and for the way in which he has striven to the top ranks. And it's a sadness for me that it has come to this point, but I don't think the board had any choice.
This was a humongous loss. It was misunderstood and, therefore, underestimated. And then the straw that broke the camel's back was when he made an unsolicited overture to Wachovia about selling the firm. Now, you just don't do that before you've cleared it with your board. And as a board member, I would have seen no other option but to take the action they took.
Wall Street CEO accountability
JEFFREY BROWN: Now, Professor Hayes, staying with you, according to reports, he's receiving no severance package but will have retirement benefits and stock awards that could total $160 million. Now, I guess most of us say that's another way that Wall Street is a little different from the rest of the world. Can you explain that kind of a package?
SAMUEL HAYES: Yes, well, it's very much in line with what other packages have been on Wall Street. And just think about the former president of the New York Stock Exchange who was given a $200 million-plus severance package, which is now being contested.
But I think that this is an example of the huge compensation packages which are given to the top managements of these investment firms. And they're rationalized as this is a very tough business, it's a business which requires a great deal of acumen, and I'm sure these people are very bright.
But when you don't deliver with that kind of high compensation, then it's all the more reason why you have to go. And I think there are a number of firms today that are just too big, and it's almost impossible to manage them. I think that may be the case in the case of Citigroup.
And I also think that it's going to be necessary to formulate some rules, and some constraints, and limits on the use of derivatives, something which the SEC has not wanted to do, because they wanted these things to be innovative and to be governed by the market.
The future for Wall Street heads
JEFFREY BROWN: Well, let me ask Roben Farzad, just in the minute we have left, as you look forward, you started to mention that some other corporate heads might be on the block here. Do you see this unfolding? Do you see more going on in the corporate suites now?
ROBEN FARZAD: Yes, unfortunately, I think the final shoe hasn't dropped in this subprime slime, as it's broadly being called on the street. Citibank has an underperforming stock. Everybody is getting hit on this. Bear Stearns saw two of its big hedge funds explode and, in many ways, precipitated much of the meltdown we saw in the summer.
You're going to see this across the board. And Professor Hayes talks about how many of these securities actually sit stagnant on these books. And until the firms, you know, take their hands off their eyes and start a reconciliation process, we're not going to know how many bodies are buried in the backyard.
Unfortunately, it's an ongoing theme, but to me it's indicative of an end of a cycle and Wall Street's reconciliation with its previous boom. And invariably, somebody is going to hand the baton and this boom off to another person. A cleanup person will come in to Merrill, reconcile its derivatives situation, and in five years we'll be talking about another boom and bust.
JEFFREY BROWN: All right, Roben Farzad and Sam Hayes, thank you both very much.
ROBEN FARZAD: Thank you.
SAMUEL HAYES: Thank you.