The balance of credit and blame

Oct 28 2007

This just in (1:07PM CST)

from The Wall Street Journal

Oct. 28, 2007

Merrill Lynch CEO Stan O’Neal has decided to leave the firm in the wake of $8.4 billion in write-downs and an unauthorized overture to Wachovia, a person familiar with the matter says. An announcement on his departure could come today or Monday morning, this person said.


And the sub-prime mess gets its first big scalp.

Yesterdays Saturday WSJ included a piece of Breakingviews commentary entitled “O’Neal Leads Race for Exit”, with the provocative subtitle “Merrill Chief Speeds Past Citi’s Prince, Bear’s Cayne On Endangered CEO List”.

Mr. O’Neal has, to all appearances, done a fine job at Merrill, recent events excluded. He’s also been amply rewarded.

Is he being turfed (let’s not pretend to believe he made this decision himself) because of the mortgage-based losses? Not directly, it seems. In no particular order:

  • Over the years (see WSJ article first linked), he’s had “issues” with competition for control, and has left numerous enemies alive to snipe at him from elsewhere
  • He spoke with Wachovia about a merger, absent board approval – major faux pas, even if he “owned” the board
  • He announced expectations of a $5 billion write down several weeks ago, but reported an actual $8.4 billion write down

The first of these makes for good gossip fodder amongst the denizens of the Street, I’m sure, and one can surely find unrequited antipathy for the CEO of any large firm, if one looks hard enough. Unless the jilted former executives have tight ties to current board members, however, they’re unlikely to have directly affected the calculus on this one.

The second of these is quite unseemly – he’s reported to have no severance arrangement in his employment agreement, but would do well ($200 million+) in the event of a change of control. If he assumed his position had become otherwise untenable, that Merrill was in deep, deep trouble, or both, the approach to Wachovia would be understandable, if still strategically and logically dubious. Appearance of a money grab is bad, emulating Britain’s Northern Rock by being seen to need help in the worst way is even worse. Either of these would be a firing offense to any competent board of directors.

Of the last item, the best thing to say might be “If you don’t know, don’t say. And if you don’t know, don’t say you don’t know, either”. Wall Street firms, particularly those with trillion dollar balance sheets, and double-particularly those run by former CFOs (the post from which Mr. O’Neal made his bones) are supposed to know what their balance sheets look like at all times. The income statement? Yeah, that’s important, but the balance sheet, and the value of items therein, isn’t supposed to be subject to nearly as much interpretation as is the income statement.

If, as CEO, you violate the first maxim above, forecast a result, and get lucky, so be it. But if you do so and miss the number within weeks, you’ve also violated the second maxim, and have shown your lack of control of the business. Pretty obviously, in a business that relies on sound risk management, this too is a firing offense.

It also stands the chance of raising the curtain on one of Wall Street’s alleged dirty secrets – the fact that they pull valuations out of thin air. Two pieces at a favorite site of mine, Going Private, touch on this subject. The first “Liquid Reflections“, discusses in some detail the innards of the CDO market. The second, an earlier piece entitled “Anatomy of a Meltdown?” describes an entirely plausible framework in which a debt market participant might easily misprice its holdings, while trying to outrun a presumed short-term disruption in the market. If Merrill’s forecasting innumeracy happens to be related to having had a “fluid” model for pricing its holdings, Mr. O’Neal won’t be the last to leave, and any new CEO (Fink/Thain/whomever) will have to be seen to be dealing aggressively with the fact that asset valuations seem to be whatever traders want them to be at any given time.

Should that happen, it has implications far outside Merrill’s walls.

Oh, and that Breakingviews commentary’s closing line?

But if he does go, it might throw attention back on the race for second place.

Let the race resume, because this melodrama has several acts yet to play, but it seems unlikely at this point that, regardless of moves in the prices of assets under their management, Messrs Cayne & Prince will repeat the mistaken actions of Mr. O’Neal.