Cruz also ordered Daula to run “stress tests” on the Hubler positions by calculating potential losses in the most extreme market scenario. How much did they stand to lose if the whole mortgage market imploded? Cruz was at her vacation home in Aspen, Colorado, for the Fourth of July weekend when she got her answer: Daula called to say he’d concluded they could lose Morgan Stanley $3.5 billion, but he still considered that an unlikely scenario. According to a person briefed on her story, Cruz told both Daula and Shear, “I don’t care what your view of probability is. Cut the position.” The risk was too great, even for her.
But whether Cruz actually gave that order is in dispute. Shear and Daula have denied she told them to cut the position. And by August, with the market in free fall, the Hubler bet had gone badly sour. Shear and Daula had managed to extract the company from $1.8 billion of the trade but had missed a crucial window of opportunity to untangle another $1.5 billion, a position that would metastasize into much more severe losses. In Cruz’s view, the two men had ignored her orders and put the company in an untenable position. They “deferred to Howie [Hubler] instead of listening to Zoe,” says one Cruz ally. Jay Dweck, a former Goldman Sachs executive who had recently joined Morgan, was heard by three people to say, “At Goldman, this isn’t happening. When they say get out, they get out. At Morgan Stanley, when Zoe says get out, people start negotiating.”
Now that the markets were virtually frozen, there was nothing anyone could do. As the reality of the situation began to sink in, Cruz became agitated. She left the building frequently for smoking breaks (asking others for cigarettes, since she wasn’t a habitual smoker). And the arguments over the trades got so heated that nearby secretaries “put their heads down and looked at their feet,” says a person familiar with the situation. “Right now, that’s a billion-dollar loss,” Cruz would yell at Shear. “If it turns into a $5 billion loss, that’s your job.”
Still, Cruz tried not to panic. In August, according to a witness, she told the board of directors, “We’re going to be the best house in a deteriorating neighborhood”—meaning Morgan Stanley would outperform the other companies on the mortgage crisis. Some have argued that Cruz underplayed the extent of the losses. But in reality, no one—not Cruz and not Mack—really understood how bad things were. As the situation continued to fall apart, Mack got more directly involved, leading risk-management meetings and investigating what went wrong. When he asked Cruz whom to blame, she urged him to fire Daula and Shear.
Cruz appeared to retain Mack’s confidence through the fall. In early November, the New York Times reported that she was still Mack’s leading choice to one day lead the company. But in truth it seemed that the paper had forced Mack’s hand. Cruz heard about the pending succession story and hovered over Mack, awaiting his answer. So Mack answered yes.
Little did Cruz know that being publicly anointed Mack’s heir apparent was the worst thing that could have happened to her at that moment. For her detractors, it was the last straw. After the story appeared, several senior executives complained to Mack that Cruz was having an insidious effect on the company. A longtime Mack associate, recruitment manager Jerry Wood, said that if Mack made Cruz the next CEO, their old colleague Vikram Pandit, who by then was running the institutional clients division at Citigroup, would raid the company for disgruntled Cruz antagonists. “Vikram has a paycheck in one hand and a voodoo doll of Zoe in the other, and we’re going to lose all these people if they think the future is Zoe Cruz,” he said, according to two people familiar with the conversation.
Mack’s reaction, they say, was, “Listen, I’m working with her, she has some rough edges, but she’s a really talented leader.”
But as Mack interviewed the parties involved, it became clear that the blame was coalescing around Cruz. When Hubler’s trading manager, Tony Tufariello, told Mack he had never liked Hubler’s mortgage positions, Mack asked why he hadn’t spoken up. “You cannot disagree with Zoe and continue to be successful at this firm,” Tufariello said, according to someone briefed on the conversation. “The more [Mack] dug into it, the more he realized [Cruz] wasn’t in touch with the situation as much as she should have been,” says a person familiar with Mack’s thinking. Plus, Mack was under intense scrutiny himself. He knew the choice he had to make.