Eureka! We have finally found the level of loss that sends the boss packing in corporate America: $8 billion. If a company’s losses in a given quarter exceed that amount, as they just did at Merrill Lynch and Citigroup, the CEO is actually out of a job! Of course, even with that torrent of red ink, you can’t get away from euphemisms. Merrill called its execution of CEO Stan O’Neal a retirement and carefully pointed out that the $160 million O’Neal got to take with him wasn’t severance, but just what the firm was contractually obligated to pay him. There was no mention that perhaps, if you lose $8 billion, you can be fired for cause and be denied the contracted pay package. If $8 billion in losses isn’t cause, what is? But it seems that no company will fire a CEO and then say “sue us for the rest of your salary,” no matter how deserving the firing might be, and this was the most compelling case for a firing that I’ve ever come across that didn’t involve outright embezzlement.
Citigroup was ridiculously gracious with Charles Prince as well, even though the losses under his régime could wind up exceeding O’Neal’s by as much as $3 billion. The world’s largest bank gave Prince the absurd courtesy of a resignation, with the company’s new chairman, Bob Rubin, the former Treasury secretary and former Goldman Sachs co-chairman, going out of his way to say that the decision was Prince’s alone and not the bank’s. The resignation came a day ahead of an emergency meeting in which the Citigroup board was expected to weigh Prince’s fate. Pure coincidence, no doubt.
If you are wondering whether these CEOs were brought down by the mistakes of their underlings or wholly unavoidable situations not of their own making, don’t even go there. These men charted and executed the exact paths that generated such colossal losses for their firms, embracing bonds backed up by residential mortgages as though they were gold. The red ink is on their fumbling hands, and it’s indelible. Indeed, the biggest surprise may be that it took so long to get them out, although the lasting damage inflicted on their organizations by the extended service of these two CEOs may prove to be at least as shocking.
Stan O’Neal, who always seemed to belong to the Joseph Stalin school of management, has spent most of his tenure firing fantastic people who challenged him, especially those like Jeff Kronthal, who directly questioned his decision to plunge into the cesspool of residential mortgages at the worst possible time, just when the housing bubble burst. O’Neal’s decision, at the exact top of the housing cycle, to buy First Franklin, one of the worst subprime-mortgage lenders, might go down with New Coke as one of the biggest corporate blunders in history. Merrill Lynch then underwrote and packaged some of the most worthless mortgages around, only to get stuck holding the absolute worst of them when no one else would buy them. When the losses from these mortgages began to cascade, O’Neal first tried to explain that only $3 billion had been flushed down the drain. Then a few weeks later, without an ounce of explanation, he announced that the loss was really $8 billion! In reality, nobody has any idea how much money has been lost, because the defaults on the bonds backed by mortgages get worse by the week. Then, on top of the losses, O’Neal tried to cover up the whole shebang by attempting to arrange a shotgun marriage with Wachovia Corp. without first checking with the board of directors. Merrill’s culture is so proud that it’s entirely possible the Wachovia double cross was more to blame for O’Neal’s exit than the massive mortgage losses. Merrill Lynch people worship Mother Merrill. O’Neal didn’t get it: He didn’t own Merrill; he just worked there.
How much was O’Neal hated before his departure? This man was Wall Street’s Wicked Witch, a much-feared, totally unrespected hatchet man who appeared to be beloved by the troops but in reality didn’t have a friend in the joint. In truth, the rank and file, many executives, and the powerful alumni (Merrill’s a bit like a college-football powerhouse—the alumni actually matter) loathed O’Neal. I swear you could hear the cheering coming from downtown when he left. In the 24 hours after the losses were announced, a half-dozen active and recently fired Merrill execs sent me the URL for a golf site, ghin.com, where golfers enter their games and scores. Sure enough, O’Neal had posted twenty scores in the past few months, as the firm bled losses from the eyeballs. A week has gone by, and I’m still looking for an exec who will defend O’Neal’s behavior, on or off the record. I can’t find one.
As reckless and capricious as O’Neal may have been, he was outdone by the Clown Prince of Citigroup, Chuck Prince, the man whom Eliot Spitzer pushed into the job when the former attorney general came close to closing the place for multiple violations of securities law. From the day he took over, Prince, a lawyer by trade who intended to restore legal order to satisfy Spitzer, was in over his head, just hopelessly inept when it came down to understanding what an investment bank does, or at least what it should do. After the bank passed muster with the regulators, he should have moved on. But no, he decided he could run a complex bank, so he set out on a series of acquisitions and buybacks that were too expensive and reckless for even his deposit base, the world’s largest, to handle. Prince accumulated underperforming hedge funds, and a second-rate brokerage in the only securities market worse than ours, Japan’s, and he backed the riskiest strategy for the era: guaranteeing billions and billions of loans, once again backed up by residential mortgages. In other words, like O’Neal he couldn’t imagine the downside to these products that had been structured by a team he seemed to be unable to comprehend or control. The man simply wasn’t smart enough to be a banker in a world where banking no longer means tellers and ATMs. Citigroup, like Merrill, got stuck with about $40 billion in mortgage guarantees and a huge inventory of crummy mortgages. If you set out to destroy a premier banking franchise, you couldn’t do half as good a job as Prince did. For a year I thought that if the bank fired Prince the stock would go higher. But the destruction he wrought gained speed, and his departure came too late to restore Citi’s luster. How bad was Prince? When Goldman’s stock dropped eleven points on the day Prince’s resignation was announced, Wall Streeters, only half-joking, attributed the decline to the loss of Goldman’s most valuable asset: a Chuck Prince–led Citigroup. The firm had simply ceased to be competitive in investment banking or trading under Prince.
Right now, both banks are scrambling to find replacements for the top. Bob Rubin has stepped up to run Citigroup for now, along with Sir Win Bischoff, an obscure British banker. There was a time when just floating the possibility that Rubin might run the bank sent the stock screaming upward. But the Street has soured on the former Treasury secretary and Goldman Sachs boss because for some unknown reason he protected and endorsed Prince throughout Prince’s reckless spending spree. He’s just another negative now. Sir Win Bischoff? At this point, we’d take any knight over Prince, including Paul McCartney or Sean Connery.
A bunch of names have been floated to run Merrill. I think Bobby McCann, an equities trader who’s the opposite of Stan O’Neal, well liked and capable of repairing the culture quickly, deserves the inside track, but Merrill’s problems are so vast and complex that it may have to bring in someone with expertise solely in mortgages and fixed income to save the joint.
While these two firms try to figure out how to right themselves, the clock is ticking. The mortgage paper these banks are stuck with sours by the day, and without rapid Federal Reserve cuts, we could see perhaps a doubling of the losses at both firms. Such depletion of capital would force both Merrill and Citigroup to sell assets at an enormous loss just to stay liquid and pay their dividends. These banks are, in effect, hostage to the whims of the Federal Reserve chairman. If Ben Bernanke wants to punish these ne’er-do-wells, all he has to do is declare his recent round of rate-cutting over. Bernanke may have to cut just to stave off a major default. Yeah, it’s that dire. Even with rate cuts, Merrill might have to be merged with a more solvent institution. Citigroup? Too big to fail, but not too big to suspend its dividend and be forced to merge with another large bank.
Could all the billion-dollar problems have been foreseen? Given that Bear Stearns, Credit Suisse, Lehman Brothers, and UBS have all suffered massive losses for this stuff, it’s tempting to think that some of this was unavoidable. But Goldman Sachs, under Lloyd Blankfein, made a bet against the exact same paper that Prince and O’Neal embraced so heavily, and he just paid out the same amount as the losses that these two knuckleheads generated together in bonuses to his employees! When you’re paid the way Wall Street CEOs are paid, you’re supposed to get this stuff right, not wrong. You are supposed to manage the risk. You are not supposed to put the franchise in jeopardy, ever. Both O’Neal and Prince did just that. Both were unchecked by anyone at their banks. Both have done lasting damage. Both deserved to go. Justice came late, but at least it came.
James J. Cramer is co-founder of TheStreet.com. He often buys and sells securities that are the subject of his columns and articles, both before and after they are published, and the positions he takes may change at any time. E-mail: firstname.lastname@example.org. Please send e-mails to: email@example.com