All The Devils Are Here: Unmasking the Men Who Bankrupted the World (32 page)

A mile or so north of Goldman’s Wall Street offices, in a high-rise complex a stone’s throw from Ground Zero, stood the headquarters of another venerable Wall Street institution, one with a name that, to most Americans, was far better known than Goldman Sachs. This firm was Merrill Lynch. It had been founded in 1914 by an intense, ambitious stockbroker named Charlie Merrill, whose notion of how to succeed on Wall Street was completely different from anyone else’s at the time. Merrill’s idea—nay, his lifelong crusade—was to sell stocks and bonds to the American middle class. For most of its history, Merrill made its money by “bringing Wall Street to Main Street,” a phrase its founder coined. Merrill Lynch was the “Thundering Herd” that was “Bullish on America.” It had brokerage offices all over the country and employed, at its peak, some sixteen thousand brokers. Merrill’s core brokerage division was a good, solid, profitable business. This was especially true after 1982, when the combination of a long bull market and legal changes that caused people to begin investing for their own retirement turned tens of millions of middle-class Americans into investors.

Merrill had a fixed-income division and an investment banking division. It had equity analysts who were highly rated by
Institutional Investor
, the arbiter of such things. It had businesses that ranked high on the “League Tables.” And it had been an absolute trailblazer in going public, which it did in 1971, only the second firm to do so. (The first was the much smaller Donaldson, Lufkin & Jenrette.) Yet it was never held in the same esteem as Morgan Stanley and Goldman Sachs. Goldman, especially, made so much
more money—and with so many fewer people! It dealt with sexy hedge funds and counterparties rather than middle-class Americans. By the early 2000s, there was no firm suffering from a worse case of Goldman envy than Merrill Lynch.

The primary reason for this was that, in 2002, Merrill Lynch elevated its president, E. Stanley O’Neal, to be the new CEO. O’Neal had joined Merrill as a trader on the junk bond desk in 1987, when he was thirty-five. Proud, prickly, intolerant of dissent, and quick to take offense at perceived slights, O’Neal had never worked as a stockbroker, and had no particular affection for the business that had long been Merrill’s heart and soul. His burning ambition was to change Merrill. He wanted to transform its “Mother Merrill” culture, which he viewed as bloated and soft—“not adequate to the times,” he once told a colleague—and he wanted to put new emphasis on trading, especially fixed-income trading, where the fat profits lie. Under O’Neal, Merrill got into the business of lending money to private equity firms. It boosted its proprietary trading desk. It greatly expanded its commodities trading business. And it bulked up its mortgage desk. Most of all, O’Neal pushed Merrill to take more risks and bigger risks—Goldman Sachs–like risks. After all, isn’t that how one made Goldman Sachs–like profits?

Stan O’Neal was the kind of man who could bristle even at comments that were meant as praise, so it is no surprise that he never found the label “African-American CEO” to his liking. Yet his was one of the great African-American success stories in modern business. O’Neal was born in the tiny town of Wedowee, in eastern Alabama, an hour due north of Auburn. It was, says a friend, “a tough town where it was dangerous for black people to look directly at white people”; well into the 1990s one of its prominent citizens publicly crusaded against interracial marriage. O’Neal’s grandfather was a slave. His father was a poor farmer who moved his family to Atlanta when Stan was twelve. They lived in a housing project until his father established himself as an assembly line worker at a nearby General Motors plant. After high school, O’Neal was accepted into a work-study program by the General Motors Institute (now known as Kettering University). GM then hired him as a shift foreman upon his graduation, and gave him a merit scholarship when he was accepted at Harvard Business School. Once O’Neal had his MBA, General Motors put him in its treasury department and gave him a series of promotions.

Although he was clearly a comer at GM, O’Neal took a job at Merrill
because he felt that it offered him more opportunity. By 1990, he had been put in charge of the junk bond desk, where he quickly impressed the top brass with both his effectiveness and his ruthlessness, something he would continue to do as he made his way up the ladder. As the head of the brokerage division when the Internet bubble burst, he laid off thousands of brokers—without asking his then boss, CEO David Komansky, for permission. As chief financial officer in the late 1990s, he sent Komansky an analysis of the company that was far tougher and more clear-eyed than the Merrill culture was accustomed to—criticizing the firm’s low profit margins and concluding that “the root causes of our uncompetitive margins are both structural and cultural.” Far from being put off by O’Neal, Komansky was impressed. “The one thing about Stan,” Komansky later told
The New Yorker
, “was that he gets things done.”

By July 2001, O’Neal had been named president of Merrill Lynch. Komansky had planned to stay on as CEO for a few more years, until he turned sixty-five, but two events forced him out earlier. The first was 9/11. Several Merrill employees died in the attack, and the firm’s headquarters were badly damaged. During and after the attacks, O’Neal took charge while Komansky seemed paralyzed. “O’Neal filled the vacuum,” recalls one former executive. Concluding that Wall Street was unlikely to recover quickly after 9/11, O’Neal instituted big layoffs. Komansky cautioned him against such a move, fearing a public backlash so soon after the terrorist attacks, but O’Neal had no patience for such thinking.

Secondly, though, O’Neal simply wasn’t willing to wait a few more years to become CEO. He was ready now. Before being named president, he’d had rivals for the top job. He outmaneuvered them, and then, as president, pushed them aside. Once he became president, he cultivated key allies in the firm who had ties to board members; they began agitating for O’Neal to take over, arguing that the firm couldn’t wait to make the changes O’Neal had in mind. By the end of 2002, Komansky had turned over the reins to O’Neal. Though he had hoped to stay on as board chairman, Komansky soon acceded to O’Neal’s demand that he give up that role as well.

Thanks to all the jockeying around O’Neal’s ascension, the Merrill Lynch executive suite had become a very political place. His appointment as CEO didn’t end the palace intrigue. Strangely, though, the next round of intrigue came not from his many enemies in the firm, but from two of his closest allies. One was Arshad Zakaria, the head of global markets and investment banking. The other, Tom Patrick, who had been Merrill’s chief financial
officer under Komansky, was effectively O’Neal’s number two, though he lacked the title of president. O’Neal had told the board he didn’t feel any need to fill the position.

Within a matter of months, Patrick began going behind O’Neal’s back to the board, pushing board members to insist that O’Neal name a president and promoting Zakaria for the job. (The reason behind Patrick’s ploy has always been a mystery, even to people at Merrill.) Although Zakaria did not openly join Patrick’s effort, he knew about the lobbying, and was lurking in the shadows. At least one board member was ready to do Patrick’s bidding.

But then, in July 2003, somebody whispered in O’Neal’s ear and told him what was going on. O’Neal responded fiercely. He went to the board, laid out what Patrick and Zakaria were doing, and demanded that the board back him—which it did. He then had Patrick escorted from the building. By early August, Zakaria was gone as well.

Almost every executive associated with Merrill Lynch at the time would later point to these firings as a critical event in the O’Neal era—and not for the better. O’Neal had always been insular; he was the kind of man who liked to play golf by himself. Now he became isolated. He had been wary; now he became suspicious of everyone around him. Patrick and Zakaria were extremely competent executives; he replaced them with more pliable lieutenants. He trusted no one but himself.

Although O’Neal didn’t realize it, this was not the way to compete with Goldman. Goldman’s executive committee members all participated in discussions about all the various businesses. O’Neal, by contrast, insisted that the company’s executives speak only to him about their businesses and not discuss the businesses with one another. The Goldman brass insisted on knowing bad news; Merrill executives trembled at the thought of giving O’Neal bad news. Whenever Goldman’s CEO had to make an important decision, he consulted with a handful of advisers to solicit their advice. O’Neal rarely asked for input when he was preparing to make a decision, and under no circumstances did he want to be challenged once he had made up his mind.

A few years after the ouster of Patrick and Zakaria, Greg Fleming, one of the few O’Neal lieutenants who had the temerity to disagree with him, was having dinner with him, pressing him on a handful of issues. As the dinner was concluding, O’Neal said, “This is getting too painful.”

“Stan, I don’t understand what you mean by ‘too painful.’ I’m just disagreeing with you,” replied Fleming.

“I don’t think we can have dinner anymore,” said O’Neal. They never did.

The Merrill culture, pre-O’Neal, had always been fearful of risk. There was a good reason for this: when the firm got too aggressive, it often got burned. Merrill, after all, was the firm that persuaded Orange County to trade derivatives in the early 1990s, resulting in the county’s 1994 bankruptcy—and a huge black eye (and a $30 million fine) for Merrill. In 1987, during the early days of mortgage-backed securities, a Merrill Lynch mortgage trader named Howard Rubin lost $250 million on one trade. That loss was big enough that Merrill stayed away from taking significant risks in the mortgage business for years. A decade later, during the Long-Term Capital Management crisis, Merrill struggled to maintain its liquidity, fearing at one point that its biggest retail money market fund might “break the buck,” a potential disaster. (O’Neal had been Merrill’s chief financial officer during the LTCM crisis.)

“Anytime a trader lost $50 million,” recalls a former Merrill trader, “it was like the Spanish Inquisition.” You couldn’t take big risks without accepting the possibility of big losses, and that was something that Merrill just couldn’t stomach. Taking a lot of risk just wasn’t part of its culture.

O’Neal pushed hard to change that, according to former Merrill executives. He was constantly asking the various desks why they weren’t taking on more risks. Sometimes when he saw the firm’s VaR number, he would actually get angry—it wasn’t
high
enough, which to him meant that Merrill wasn’t taking the kinds of risks it should be taking. He backed his department heads when they wanted to hire aggressive young turks while getting rid of those who didn’t have the risk appetite he was looking for. And he constantly compared Merrill’s performance to Goldman’s. “You didn’t want to be in Stan’s office on the day Goldman reported earnings,” recalls one of his former lieutenants.

Everybody on Wall Street had a big mortgage desk, Merrill Lynch included. By the time O’Neal became CEO, they were all beginning to focus on underwriting collateralized debt obligations that included at least some percentage of subprime mortgages. With this new CDO market up for grabs, Merrill decided to go all in. Within just a few years, Merrill was the dominant underwriter of CDOs, taking the business from nine CDO deals worth $2.2 billion in 2002 to thirty-eight deals worth nearly $19 billion in 2004. It went from fifteenth in the ranking to first. Between 2002 and 2007, Merrill Lynch underwrote one hundred CDOs, twenty-seven more than runner-up Citigroup. Merrill’s management viewed its number one ranking as proof positive
it could play with the big boys, and that ranking became something to be preserved at all costs.