All the Devils Are Here [103]
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.
The man who had the ultimate authority over the mortgage desk for Merrill Lynch in those days was a veteran trader named Jeff Kronthal. He had spent his career around mortgage-backed