Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-Collapse of Bank of America
512
Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-Collapse of Bank of America
512eBook
Available on Compatible NOOK devices, the free NOOK App and in My Digital Library.
Related collections and offers
Overview
With one notable exception, the firms that make up what we know as Wall Street have always been part of an inbred, insular culture that most people only vaguely understand. The exception was Merrill Lynch, a firm that revolutionized the stock market by bringing Wall Street to Main Street, setting up offices in far-flung cities and towns long ignored by the giants of finance. With its “thundering herd” of financial advisers, perhaps no other business, whether in financial services or elsewhere, so epitomized the American spirit. Merrill Lynch was not only “bullish on America,” it was a big reason why so many average Americans were able to grow wealthy by investing in the stock market.
Merrill Lynch was an icon. Its sudden decline, collapse, and sale to Bank of America was a shock. How did it happen? Why did it happen? And what does this story of greed, hubris, and incompetence tell us about the culture of Wall Street that continues to this day even though it came close to destroying the American economy? A culture in which the CEO of a firm losing $28 billion pushes hard to be paid a $25 million bonus. A culture in which two Merrill Lynch executives are guaranteed bonuses of $30 million and $40 million for four months’ work, even while the firm is struggling to reduce its losses by firing thousands of employees.
Based on unparalleled sources at both Merrill Lynch and Bank of America, Greg Farrell’s Crash of the Titans is a Shakespearean saga of three flawed masters of the universe. E. Stanley O’Neal, whose inspiring rise from the segregated South to the corner office of Merrill Lynch—where he engineered a successful turnaround—was undone by his belief that a smooth-talking salesman could handle one of the most difficult jobs on Wall Street. Because he enjoyed O’Neal’s support, this executive was allowed to build up an astonishing $30 billion position in CDOs on the firm’s balance sheet, at a time when all other Wall Street firms were desperately trying to exit the business. After O’Neal comes John Thain, the cerebral, MIT-educated technocrat whose rescue of the New York Stock Exchange earned him the nickname “Super Thain.” He was hired to save Merrill Lynch in late 2007, but his belief that the markets would rebound led him to underestimate the depth of Merrill’s problems. Finally, we meet Bank of America CEO Ken Lewis, a street fighter raised barely above the poverty line in rural Georgia, whose “my way or the highway” management style suffers fools more easily than potential rivals, and who made a $50 billion commitment over a September weekend to buy a business he really didn’t understand, thus jeopardizing his own institution.
The merger itself turns out to be a bizarre combination of cultures that blend like oil and water, where slick Wall Street bankers suddenly find themselves reporting to a cast of characters straight out of the Beverly Hillbillies. BofA’s inbred culture, which perceived New York banks its enemies, was based on loyalty and a good-ol’-boy network in which competence played second fiddle to blind obedience.
Crash of the Titans is a financial thriller that puts you in the theater as the historic events of the financial crisis unfold and people responsible for billion of dollars of other people’s money gamble recklessly to enhance their power and their paychecks or to save their own skins. Its wealth of never-before-revealed information and focus on two icons of corporate America make it the book that puts together all the pieces of the Wall Street disaster.
Product Details
| ISBN-13: | 9780307717887 |
|---|---|
| Publisher: | Crown Publishing Group |
| Publication date: | 11/02/2010 |
| Sold by: | Random House |
| Format: | eBook |
| Pages: | 512 |
| Sales rank: | 186,839 |
| File size: | 2 MB |
About the Author
Read an Excerpt
CHAPTER 1
THE YOUNG TURK
"My name's Tom Spinelli," said the man at the microphone. "Good morning, Mr. O'Neal, members of the board, executive committee, and fellow shareholders. I would like to apologize in advance if my voice appears to be too loud. The reason is because I have subjective tinnitus; it's a hearing disorder."
Spinelli was in the auditorium of Merrill Lynch's sprawling corporate center outside Princeton, New Jersey, on the occasion of the company's annual meeting on April 27, 2007. Merrill Lynch's chief executive, Stan O'Neal, had just reviewed the ninety-three-year-old firm's record-breaking results in 2006 for his audience. The company he had led since 2002 posted $7.3 billion in profits for the previous year, dwarfing the 2005 earnings of $5 billion, which were also a record. O'Neal could now bask in the glow of his success and soak up the praise bestowed by Spinelli and other investors.
"I would like to emphasize that I've been an employee, client, and shareholder for over thirty-five years," Spinelli continued. "I do know that during your tenure here at Merrill Lynch I have discovered a wealth of new products and services unlike anything I've ever seen in the past. As a client it has enabled me to take full advantage of so many excellent investment opportunities in the marketplace. I am now in a position to provide a much more secure financial future for members of my family and myself.
"This is a comment and a personal observation. I neither have the inclination or frame of mind to put you in an awkward position. However it should be stated that thanks to your knowledge, skills, superb leadership, and the expertise of designated members of the executive committee, Merrill is now back and in excellent competitive form."
Annual shareholder meetings, supposedly the great democratizing force of corporate America, are curious affairs, with CEOs re-elected almost by acclamation by the votes of institutional investors representing huge blocs of votes. The few individual shareholders who do attend often fall into one of two categories: activists agitating for change and well-meaning individuals entranced by the prospect of getting themselves in front of a microphone before a captive audience.
"As you know, the 2008 presidential election is starting to heat up again," Spinelli went on. "I'm convinced that the Democrats will win back the White House in the aforementioned election. Under our new presidential administration I am confident that you will be called upon [by] our president-elect to serve as his, as an elite member of his or her new cabinet.
"It would be similar to what late President Ronald Reagan did for former chairman and CEO of Merrill Lynch, Don Regan, in 1980, who quietly slipped away in 2003. If you accept to do for our country what you have done for Merrill Lynch, I would no longer just be a content American, I would be a proud American. Thank you and have a nice day."
O'Neal smiled at this bouquet of gushing praise. "Just the opposite of being too loud," the CEO said facetiously, pretending not to hear. "If you would say that again . . . I'm not sure I caught all of it." The audience broke up in laughter.
"Thank you very much for your comments," O'Neal continued. "And I have no intention of going anywhere, I'm afraid, because this is where I want to be. Thank you."
The annual meeting ended, and O'Neal exulted in his achievements. He had, single-handedly it seemed, rescued Merrill Lynch from irrelevance and established himself as one of the most successful CEOs on Wall Street and in corporate America.
Leaving the conference center, O'Neal would join his directors for a board meeting at the Nassau Inn, in Princeton, just a short drive away.
Early in 2007, problems emerged in the U.S. real estate market--the great engine of growth across the country over the previous decade. Home prices had stopped appreciating in high growth markets such as California, Nevada, Arizona, and Florida, and as a result, mortgage companies reported an alarming increase in foreclosures. The mortgage companies with the weakest credit standards, such as New Century, failed, while Countrywide, the largest mortgage originator in the country, had fallen on hard times.
While the problems of the real estate market in other parts of the country seemed distant from Wall Street, investment banks such as Merrill Lynch had derived more and more of their revenues from underwriting mortgage-backed securities--bonds which had been created by packaging large groups of mortgages together. For that reason, O'Neal thought it prudent to present his board with an overview of the market for mortgage-related products. Osman Semerci, a rising star at Merrill Lynch, would make this presentation and walk the board of directors through Merrill Lynch's fixed-income exposures.
Just nine months earlier, O'Neal had encouraged the selection of Semerci, a thirty-eight-year-old native of Turkey, to be head of Merrill Lynch's fixed-income, commodities, and currencies business, an area known on Wall Street as "FICC." The term "fixed income" had grown more important on Wall Street over the previous decade because of the proliferation of products that, like bonds, provided a steady stream of payments to the owner. When he was stationed in Tokyo and then in London, Semerci had established himself as a master in the art of selling fixed-income products to other banks and investors.
Nestled comfortably in a dining room at the Nassau Inn, the directors listened closely as Semerci outlined the successes he had engineered in less than one full year on the job: record revenues in FICC for 2006, followed by record revenues in the first quarter of 2007. In addition to the board, several other Merrill Lynch executives sat in on the presentation, including Ahmass Fakahany, the vice chairman and chief administrative officer; Jeff Edwards, the chief financial officer; Rosemary Berkery, the general counsel; and Laurence Tosi, chief operating officer of the global markets and investment banking division of Merrill Lynch.
From a competitive standpoint, Semerci explained, Merrill Lynch was trouncing its competition in year-over-year improvement in his department, with a 36 percent increase in FICC revenues for the first quarter of 2007 over the previous year's first quarter. By contrast, Morgan Stanley showed a 31 percent improvement, while mighty Goldman Sachs--the perennial leader in almost every Wall Street category--had improved by only 20 percent.
It was now clear why O'Neal had touted Semerci to the board as potential CEO material. Poised and elegant, Semerci demonstrated to the board how he had figured out the formula for maximizing the company's revenues in an overheated real estate market without exposing Merrill Lynch to any of the downside of the real estate crash. Of the company's $9.2 billion in FICC revenues for 2006, Semerci explained, only 6 percent--or some $550 million--came from U.S. mortgages. Another 15 percent, or $1.4 billion, came from securitization and foreign mortgages. Merrill's total exposure to the subprime market amounted to less than 2 percent of its revenues.
Semerci then handed the presentation over to Michael Blum, a subordinate who managed global structured finance and investments. If there was any danger on Merrill's balance sheet from mortgage-related bets, it would be in Blum's department, which securitized large pools of mortgages and then sold them to other banks and investors. In the previous two years, Merrill Lynch had generated $700 million in revenues from packaging mortgages into CDOs, large concentrations of similar-type mortgages that could either turn into bars of gold for the acquirer or radioactive bricks that disintegrated in value.
When the real estate market was strong, CDOs were enormously popular, since they promised investors a steady stream of payments at a higher percentage rate than most corporate bonds would pay. For several years, the manufacturing of CDOs was akin to the smelting of gold bars. Merrill Lynch and other banks received fees for forging the CDOs, and were able to sell the products with ease.
As the real estate market overheated in 2005 and 2006, the quality of the mortgages being used to manufacture CDOs deteriorated. Wall Street banks started making CDOs from subprime loans to people who normally wouldn't qualify for a home loan or who put little or no down payment on a house. In these conditions, CDOs forged from questionable ingredients might turn into bars of gold, if the economy remained strong and the home buyers behind the mortgages kept making their payments, but these latter vintage CDOs were no longer a sure bet. Just the opposite: In the spring of 2007, many of the CDOs circulating in the marketplace were already showing signs of turning into bricks of radioactive waste. It was one thing to make and market these products, but Merrill Lynch's board and management did not want to own the CDOs.
Blum was unsparing in his description of the shift that had taken place in the markets. The quality of mortgages had dropped dramatically and posed dangers to any bank, such as Merrill Lynch, that participated. He walked the directors through his efforts to limit Merrill Lynch's exposure to CDOs. He showed how his department had reduced a $17.7 billion subprime mortgage exposure the previous September to $3.5 billion as of the date of his presentation.
At the end of his talk, the directors seemed satisfied with Merrill's position in the declining mortgage markets. One member of the board, Virgis Colbert, asked a follow-up question.
"Is that all the subprime you have?" he asked Blum.
Blum turned to his boss, Semerci, who was responsible for all FICC investments, not just deals struck in the global structured finance department.
"That's it," said Semerci.
It was known among some of the traders on the seventh floor as the "Voldemort book" because, like the villain of the Harry Potter stories, the mere mention of it was discouraged. Few people outside Semerci's tight circle were told about the portfolio of super senior CDOs held within the department. But after the blow-up of two Bear Stearns hedge funds in June 2007, Stan O'Neal requested a board presentation about Merrill's CDOs, and details about what was in the "Voldemort book" began to trickle out.
In early July, John Breit returned from a conference in France when he heard from some of his people that they had been contacted by Dale Lattanzio, Semerci's second in command. Breit, a physicist by training, had been a risk manager for Merrill's fixed-income group until a year earlier. The people in his group, who had studied mathematics in great depth, were known as "quants" because of their expertise in complex quantitative calculations. Lattanzio had shown the quants some paperwork for exotic CDO products comprised of subprime mortgages known as "CDO-squareds" to make sure their valuation was correct.
Breit was puzzled. There was a group in place in the FICC department that could have handled this request from Lattanzio easily. It seemed suspicious that Lattanzio would want to go outside the usual channels for an opinion on a product of this sort. In presenting the package of CDO-squareds, Lattanzio eventually told Breit that it was a small position, $6 billion maximum, and that he just wanted to make sure his method of evaluating the amount of losses on that $6 billion position was right. But Breit told him that his valuation was way off. Lattanzio, a forceful man with the build of a football player, backed down, urging the former risk manager not to worry, because the investment was just a small part of a much bigger position. Struck by the irregular nature of Lattanzio's request, and the revelation that there was a much larger trove of CDO products where this one position had come from, Breit brought the matter to Greg Fleming's attention. Fleming, Merrill Lynch's co-president, encouraged Breit to keep digging into the FICC positions and see if there were other problems with Semerci's books.
Two weeks later, on July 17, 2007, Merrill posted second-quarter earnings of $2.1 billion, on revenues of $8.7 billion. But the widely reported news of losses at the Bear Stearns hedge funds--billions of dollars--raised widespread concern on Wall Street that the mortgage meltdown might affect CDO values at other banks.
O'Neal sent a memo to the firm's employees touting his team's ability to manage risk. "Over the last six months, we have worked successfully to position ourselves for a more difficult market for CDOs and have been proactively executing market strategies to significantly reduce our risk exposure," he wrote. "As a result, we are very comfortable with our current exposure to this asset class." On July 22, Merrill's board of directors met at the St. Regis Hotel on East 55th Street in Manhattan, just off Fifth Avenue, and one of the topics on the agenda was how Merrill Lynch would be affected by recent events in the markets.
During a meeting of the board's finance committee, Tosi, the chief operating officer of Merrill's global markets and investment banking division, made a presentation about the spin-off of Barry Wittlin, one of Merrill's top bond traders, into Wittlin Capital Group. After finishing his presentation, Tosi decided to stay for the balance of the meeting, and plopped himself down in a seat near Stan O'Neal to hear the update of subprime exposures in FICC from Semerci and Lattanzio.
Lattanzio had relocated to New York after Semerci was promoted the year before. He and his boss presented a chart that showed Merrill Lynch as the leader in CDO production for the first half of 2007, with $34.2 billion in volume. The nearest competitor was Citigroup, which had done $30.1 billion in CDOs for the first six months of 2007, and then eight other banks, rounding out the top ten. Goldman Sachs didn't even make the list, having apparently dropped out of the business of manufacturing CDOs. On a separate slide, Lattanzio revealed something that would have shocked some of his own traders: The firm had accumulated $31 billion in CDOs on its balance sheet.
But Merrill Lynch was managing its CDO business prudently, Lattanzio said, describing several hedges, or counter-bets, the firm had made to protect itself from the continuing decline of the real estate market. As Semerci looked on approvingly, Lattanzio said that if the market continued the negative trend that had taken hold in the second quarter, Merrill Lynch would only lose $73 million on its mortgage exposures, a tiny sum for a bank with earnings of more than $7 billion the year before.
Sitting at the far end of the table, Tosi grew alarmed. As chief operating officer of global markets and investment banking, he felt he should know what the FICC unit's positions were. Three months earlier, Semerci had told the entire board that Merrill's mortgage exposures were minimal--less than 2 percent of the firm's revenues. But now he and Lattanzio were saying that Merrill Lynch had manufactured a total of $34 billion in CDOs in the first half of 2007 alone, of which $31 billion remained on Merrill's balance sheet, at a time when no savvy investor was putting money into those products. Tosi began scribbling notes furiously to Jeff Edwards, Merrill's chief financial officer, who was sitting beside him. The back and forth messaging seemed to distract O'Neal.
After Semerci and Lattanzio finished, O'Neal thanked them, and the FICC executives stepped out into the hallway. Tosi was furious and went up to Semerci and started challenging him about the mass of CDO positions, of which he'd been completely unaware, sticking his finger in his colleague's chest. Lattanzio, much larger than either, came over to separate the men physically.
"I'm not talking to you anymore!" Semerci shouted at Tosi, before storming off.