Stephen’s Posterous

Barnet Frank on the Financial Road Ahead by Avi Salzman, Barrons.com

Rep. Barney Frank (D., Mass.), the chairman of the House Financial Services Committee, has been one of the busiest men in Washington in recent months. So busy, in fact, that when a Barrons.com reporter started a telephone interview with him recently, he dispensed quickly with the formalities.

"Let's go," he said, in an accent that betrays his northern New Jersey roots, before embarking on a wide-ranging interview on whether to nationalize banks, how to rate debt, and how long mark-to-market accounting rules will remain relaxed.

You have talked a lot about the federal government having a systemic risk agency, with the Federal Reserve overseeing it. How would it work?

The Fed took a bit of a roughing up over the AIG bonuses, so it is now unlikely that it would be the Fed alone, though the Fed will have to play a major role. At this point there is more agreement on what than who. It has to have a systemic risk capacity to keep in particular nonbanks from getting overly leveraged.

Are you interested in limiting the size of banks?
 
No. There are always the antitrust laws, but if you look at a typical antitrust law, that doesn't work because no bank is big enough to be that kind of monopoly. By the way the problem seems to be less banks than nonbanks.

I think the problems were with Lehman and AIG and Bear Stearns. What I want to do is to have a systemic risk regulator that keeps any entity from getting so heavily indebted beyond its capacity to pay that it becomes too interconnected to fail.

And who will determine what overleverage is? How much leverage is too much?

A systemic risk regulator [will determine it]. It's in two ways; it's an individual situation and it could also be if too many people get in the same side of the boat it starts to tip over.

Paul Krugman, the liberal economist who just won the Nobel Prize, has talked about banks having to be nationalized to save the system. Is that something that you feel the Obama administration should do?

The president addressed that pretty well. As far as banks being nationalized, which banks? How many? All banks? Ten banks? Three banks? One bank? I mean, of course, I would not rule out a bank being nationalized. It is a tool that might be necessary, but it ought to be a much later resort than now. I don't see any need to do it now.

Some concern has been raised about pension funds investing in hedge funds. Should the government regulate pension investments in hedge funds?

I have limited jurisdiction over that because the pension funds are under Erisa [Employee Retirement Income Security Act], which is in the Education and Labor Committee. They are talking about some kind of safeguards.

I do believe that the hedge funds should be among those entities that are not allowed to get too leveraged, and I believe that they should be required to register with the Securities and Exchange Commission.

And give data on how much leverage they are using?

Well the SEC wouldn't be primarily [overseeing] the leverage thing -- they would be an investor and consumer protection entity. The systemic risk regulator would be looking at leverage with them as with any other entity.

So a systemic risk regulator would have access to the amount of leverage that hedge funds are using.

Any financial entity, yes.

How is the government going to make investors comfortable investing in financial markets? Some investors say that the rules have changed a lot. What's the timetable [on the rule changes]?
 
By the end of the year. I hope by the time Congress adjourns for the year, which may be very late this year. Yes, there is uncertainty now. I do think it's important to provide that kind of stability, and this is a case where regulation is very pro-market because it should give people that assurance.

What reforms do you mean specifically?

The systemic risk regulator, a way to resolve nonbank institutions, a buffing-up of the investor-consumer protection functions at the regular regulators. A change in compensation rules so that people cannot give one-way bonuses and then incentivize excessive risk, and rules that say you can't securitize 100% [of a loan].

You have to retain say 5%, but it still has to be worked out. A fundamental part of the problem was that 100% securitization led to a significant drop in people's focusing on the quality of the loans they made.

Are the credit-rating agencies fundamentally flawed? Does the government need to step in and in what capacity?
 
First of all, the thing to do about rating agencies is to make them less important. If there are enough flaws [with the debt] in the beginning, there is nothing they can do about it. The payment model clearly ought to be changed.

There were biases that grew from the fact that the [corporations] being rated were paying them. I have not myself [figured out] what the best way to do it is -- whether you have investor-paid models or whether there is a government model. Clearly the current system needs to be replaced.

Do you feel that Goldman Sach's (ticker: GS) move [to try to pay back TARP money] is problematic because it could expose other banks in the eyes of investors and the public?
 
No, I am all for it. It is a very good idea. In the first place the notion that 'Oh, if Goldman pays the money back people will know that some institutions are stronger than others' is ridiculous. People already know that. There are all kinds of metrics for deciding which financial institution is strong and which one is weak.

Now do you think that TARP and the PPIP [the government's Public-Private Investment Program to buy up bad assets] will be enough money to get us out of this or are you going to need to have more money?

They are going to have to do the best they can right now. Of course with the PPIP they have gotten the FDIC [Federal Deposit Insurance Corp.] involved as a way to get that going. I do not think there is any prospect of Congress voting more money until and unless people start to see some results.

That is why I am in favor of the TARP money being paid back -- to the extent that you get some substantial repayments of TARP money if you do need more money for some other purpose later on.

As far as mark-to-market accounting reforms, do you think the rules should continue to be relaxed?

Yes. It's indefinite. What is temporary is the discretion that the regulator should show. There are two aspects to mark-to-market. One is the actual valuation, and two is how the regulators react. I do think that at a time like this there is a reason for some administrative and regulatory discretion and that would be temporary.

If things get better then you don't have that same kind of forbearance. As to the mark-to-market rules themselves, they were a little bit too rigid. They didn't differentiate sufficiently it seemed to me between assets held for trading and assets (that were paying assets) that were to be held to maturity. And [the reforms to that are] not going to change.

Are we papering over some of the larger systemic problems in the system by changing or relaxing mark-to-market right now?

I think that's nonsense. It's a straw man. It's not what we are doing in mark-to-market. If you are holding an asset and you plan to hold it until maturity and it is paying as it was supposed to, I don't think you should have to mark it down substantially. The federal home loan banks in a couple of areas were forced to do excessive markdowns. It's not either or -- it's how well you do it.

Do you think that Obama has the right people in charge right now of economic and financial matters?
 
Yes.

Some of the concern is that maybe these guys are too close to some of the people they are regulating. I'm talking about Tim Geithner and Lawrence Summers for instance?
 
I don't think that's true. Who did you think I meant? Frick and Frack?

Source.

If the Wall Street investment bank was supposedly trampled by the panic of 2008, someone forgot to tell Goldman Sachs. The credit crisis killed off Bear Stearns, Lehman Brothers and ended Merrill Lynch’s independence. Goldman, the last of its peers to go public, has recovered from its fourth-quarter loss to make $1.8bn in the first three months of the year, more than double analysts’ estimates.

And that’s despite some poor numbers in some of its core businesses: incentive fees on hedge funds were virtually non-existent, principal investments recorded a $1.4bn net loss and depressed equity and mergers and acquisitions markets hit investment banking fees and prime brokerage revenue.

In truth, it’s hard not to gander at Goldman’s earnings and conclude the firm, which along with rival Morgan Stanley sought refuge by becoming a bank holding company, is trying to prove the investment bank model it appeared to have dropped is still alive and kicking. For starters, the firm’s black box trading operations provided most of the juice. Second, in an act that seems like biting its thumb to Congress, Goldman set aside more revenue to pay staff, both as a percentage of revenue and on an absolute basis, than last year.

And Goldman executives also appear to have called a halt to shrinking the group’s balance sheet. Sure, assets only rose by 5% since last quarter to $925bn, but that’s a stark change to the deleveraging that has beset the financial sector for a year or more.

Those are some punchy tactics for a firm hoping to convince the Treasury to allow it to pay back the $10bn of taxpayer-funded capital foisted upon it last autumn. But Goldman appears to have the numbers to back it up and to persuade shareholders to stump up for its $5bn stock sale. If Goldman is any evidence, Wall Street isn’t in its coffin just yet.

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From Alan Greenspan, former chairman of the Federal Reserve and president of Greenspan Associates LLC.

Global economic policymakers are currently confronted with their most daunting challenge since the 1930s. There is considerable fear in the marketplace that the unprecedented set of stimulus programmes and efforts to recapitalise banks with sovereign credits will fall short of success. It is thus useful to contemplate alternatives to that distressing outcome.

Over the past two centuries, global capitalism has experienced similar crises and, up until now, has always recovered and proceeded to achieve ever higher levels of material prosperity. What would today’s world look like if, instead of the vast government policy efforts to stem the onset of crisis, we had allowed market mechanisms and automatic stabilisers, currently built into most of our economies, to function without any additional assistance?

Counterfactual scenarios are highly problematic to say the least. But there are intriguing possibilities that offer comfort that, if all else fails, the global economy is not on a track towards years of stagnation or worse.

In one credible scenario, behind the unprecedented loss of wealth during the last year and a half, lie the seeds of recovery. Stock markets across the globe have to be close to a turning point. Even if a stock market recovery is quite modest, as I suspect it will be, the turnround may well have large (and positive) economic consequences.

For a few months before the August 2007 disruption, the crisis was wholly financial. The world’s non-financial sector balance sheets and cash flows were in good shape. But the contagion from the crisis in finance took hold in the autumn of 2007. Global stock prices peaked at the end of October and then progressively declined for nearly a year into the Lehman crisis. Global losses in publicly traded corporate equities up to that point were $16,000bn (€12,000bn, £11,000bn).

Losses more than doubled in the 10 weeks following the Lehman default, bringing cumulative global losses to almost $35,000bn, a decline in stock market value of more than 50 per cent and an effective doubling of the degree of corporate leverage. Added to that are thousands of billions of dollars of losses of equity in homes and losses of non-listed corporate and unincorporated businesses that could easily bring the aggregate equity loss to well over $40,000bn, a staggering two-thirds of last year’s global gross domestic product.

This combined loss has been critically important in the disabling of global finance because equity capital serves as the fundamental support for all corporate and mortgage debt and their derivatives. These assets are the collateral that powers global intermediation, the process that directs a nation’s saving into the types of productive investment that fosters growth.

I find it useful to think of the world economy’s equity capital in the context of the global consolidated balance sheet. All debt (public and private) and derivatives cancel out, leaving intellectual and physical assets at market value on the left-hand side of the balance sheet and the market value of equity on the right-hand side.

Changes in equity values result in equal changes on both sides of the balance sheet. Debt and derivatives are best seen as a grossing up, reflecting the degree of intermediation or leverage.

The consolidated global equity is also, by construction, the sum of the separate but additive equities of all individual corporations, other businesses, households and governments. At some point, global stock prices will bottom out and rise. A rise in global private sector equity will tend to raise the net worth (at market prices) of virtually all business entities.

In a bull market, the vast majority of stock prices rise. Newly created equity tends to be arbitraged across global businesses. In the current environment, new equity will open up frozen markets and provide capital across the globe to companies in general, and banks in particular. Greater equity, after addressing the shortage of bank net worth, will support more bank lending than currently available, enhance the market value of collateral (debt as well as equity), and could reopen moribund debt markets.

In short, liquidity should re-emerge and solvency fears recede. Restoration of normal global lending could be as effective a stimulus as any fiscal programme of which I am aware.

Widespread capital gains will add equity to balance sheets, but aside from increasing liquidity and decreasing insolvency, they do not in themselves raise economic activity. The fact that claims on business entities are, in effect, purchasing power, does. Most automotive dealers, for example, being compensated for the inconvenience, would presumably accept shares of stock as payment for a car.

We see this process more generally in the so-called wealth effect, where the creation of capital gains augments spending and gross domestic product, whereas capital losses lower spending.

We too often think of fluctuations in stock prices in terms of “paper” profits and losses that are somehow not connected to the real world. But the evaporation of the value of those “paper claims” over the past 18 months has had a profoundly deflationary impact on global economic activity. Failures of intermediation have hobbled many economies over the decades, most conspicuously Japan in the 1990s.

The household wealth effect on personal consumption expenditures has been documented, but stock prices have a statistically highly significant impact on private capital investment as well. Such analyses suggest that much of the recent decline in global economic activity can be associated directly or indirectly with declining equity values.

Of course, it is not simple to disentangle the complex sequence of cause and effect between change in the market value of assets and economic activity. If stock prices were wholly reflective of changes in economic variables, movements in asset prices could be modelled as endogenous and given little attention. But they are not.

A significant part of stock price dynamics is driven by the innate human propensity to swing intermittently between euphoria and fear, which, while heavily influenced by economic events, nonetheless has a partial life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but a key cause of it.

Stock prices are governed through most of the business cycle by profit expectations and economic activity. They appear, however, to become increasingly independent of that activity at turning points. It is this property that makes them a leading indicator, which is the conclusion of most business cycle analysts.

The substitution of sovereign credit for private credit has helped to fend off some of the extremes of the solvency crisis. However, when we look back on this period, I very much suspect that the force that will be seen to have been most instrumental to global economic recovery will be a partial reversal of the $35,000bn global loss in corporate equity values that has so devastated financial intermediation. A recovery of the equity market, driven largely by a receding of fear, may well be a seminal turning point of the crisis.

The key issue is when. Certainly by any historical measure, world stock prices are cheap, even after the recent run-up. But as history also counsels, they may or may not get a lot cheaper before they decisively return to more normal levels. What is undeniable is that stock market prices today are being suppressed by a degree of fear not experienced since the early 20th century (1907 and 1932 come to mind).

But history tells us that there is a limit to how deep, and for how long, fear can paralyse market participants. The pace of economic deterioration cannot persist indefinitely.

It is the rate of decline of product, labour and financial markets that generates much of the uncertainty that, in turn, fuels fear. To an employed person, it is the rate of job cuts, more than the level of unemployment, that fosters job insecurity and the economic responses that go with it. The current pace of deterioration is bound to slow and with it there should come a lessening of the level of fear.

One cause of fear is uncertainty. This uncertainty is reflected in the spread of corporate bond yields over US treasuries. The spread has historically exhibited consistent upside and downside limits clearly indicated by data going back to the 1870s. Today we are at an outer extreme of historic credit risk.

As the level of fear recedes, stock market values will rise. Even if we recover only half of the $35,000bn global equity losses, the quantity of newly created equity value and the additional debt it can support are important sources of funding for banks. As almost everyone is beginning to recognise, restoring a viable degree of financial intermediation is the key to recovery. Failure to do so will significantly reduce any positive impact from a fiscal stimulus.

Source.

Hedge fund manager David Einhorn's Greenlight Capital recently took a 5.2% stake in Ticketmaster, according to regulatory filings.

Einhorn is best known for his infamous short positions against Allied Capital and Lehman Brothers, but his investment in Ticketmaster seems to indicate a vote of confidence in the stock, says Alan Gould, a senior analyst at Natixis Bleichroeder who follows Live Nation.

Indeed, most of Einhorn's positions are long and include investments in companies like Microsoft and Target. "Einhorn is a very sharp, value-oriented manager," Gould notes, suggesting that Einhorn chose to pick up his nearly 3 million shares because he thinks Ticketmaster's stock is at a good price. Currently trading at around $4 a share, TKTM has likely been bogged down by concerns that its proposed merger with Live Nation wouldn't be approved for antitrust reasons.

Widely considered a savvy investor on Wall Street, Einhorn's position could bolster Ticketmaster's stock price, giving the ticketing company an unlikely ally in this contentious period.

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From George Soros, Chairman of Soros Fund Management and Founder of the Open Society Institute

The forthcoming Group of 20 meeting is a make-or-break event. Unless it comes up with practical measures to support the less developed countries, which are even more vulnerable than the developed ones, markets are going to suffer another sinking spell just as they did last month when Tim Geithner, Treasury secretary, failed to produce practical measures to recapitalise the US banking system.

This crisis is different from all the others since the end of the second world war. Previously, the authorities got their act together and prevented the financial system from collapsing. This time, after the failure of Lehman Brothers last September 2008, the system broke down and was put on artificial life support. Among other measures, both Europe and the US in effect guaranteed that no other important financial institution would be allowed to fail.

This necessary step had unintended adverse consequences: many other countries, from eastern Europe to Latin America, Africa and south-east Asia, could not offer similar guarantees. As a result, capital fled from the periphery to the centre. The flight was abetted by national financial authorities at the centre who encouraged banks to repatriate their capital.

In the periphery countries, currencies fell, interest rates rose and credit default swap rates soared. When history is written, it will be recorded that in contrast to the Great Depression protectionism first prevailed in finance rather than trade.

Institutions such as the International Monetary Fund face a novel task: to protect the periphery countries from a storm created in the developed world. Global institutions are used to dealing with governments; now they must deal with the collapse of the private sector.

If they fail to do so, the periphery economies will suffer even more than those at the centre, because they are poorer and more dependent on commodities than the developed world. They also face $1,440bn (€1,060bn, £994bn) of bank loans coming due in 2009. These loans cannot be rolled over without international aid.

Gordon Brown, the UK prime minister, recognised the problem and designated the G20 meeting to address it. Yet profound attitudinal differences have surfaced, particularly between the US and Germany. The US has recognised that the collapse of credit in the private sector can be reversed only by using the credit of the state to the full.

Germany, traumatised by the memory of hyperinflation in the 1920s, is reluctant to sow the seeds of future inflation by incurring too much debt. Both positions are firmly held. The controversy threatens to disrupt the meeting.

Yet it should be possible to find common ground. Instead of setting a universal target of 2 per cent of gross domestic product for stimulus packages, it is enough to agree that the periphery countries need aid to protect their financial systems. This is in the common interest. If the periphery economies are allowed to collapse, the developed countries will also be hurt.

As things stand, the G20 meeting will produce some concrete results: the resources of the IMF are likely to be doubled, mainly by using the mechanism of the “new arrangements to borrow”, which can be activated without resolving the vexed question of reapportioning voting rights.

This will be sufficient to enable the IMF to help specific countries at risk but it will not provide a systemic solution for the less developed countries. Such a solution is readily available in the form of special drawing rights. SDRs are complex but they boil down to the international creation of money. Countries that can create their own money do not need them but periphery countries do. The rich countries should therefore lend their allocations to the nations in need.

Recipient countries would pay the IMF interest at a very low rate, equivalent to the composite average treasury bill rate of all convertible currencies. They would have free use of their own allocations but would be supervised in how the borrowed allocations were used to ensure they were well spent.

In addition to the one-time increase in the IMF’s resources, there ought to be a big annual issue of SDRs, of say $250bn, as long as the recession lasts. It is too late to use the April 2 G20 meeting to agree this, but if it were raised by President Barack Obama and endorsed by others, this would be sufficient to give heart to the markets and turn the meeting into a resounding success.

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John Thain is giving us a tour of what is soon to become America’s most infamous office, with its $87,000 rug, $68,000 sideboard, $28,000 curtains, all part of a $1.2m redecoration scheme. This was early December 2008, a little under two months before Thain would be fired in the same room by his new boss, Ken Lewis, chief executive of Bank of ­America.

For now, before a price tag had been placed on every item in his office, the 53-year-old chief executive of Merrill Lynch was in high spirits. The worst year on Wall Street in nearly a century was coming to an end, and Thain could rightfully claim to have saved his bank from ruin.

Over a weekend in mid-September, as Lehman Brothers collapsed into bankruptcy, Thain pulled off a coup: he persuaded BofA, one of the few financial giants in the US that didn’t need government money to survive, to pay $29 per share for his own firm, even though Merrill was days away from following Lehman into bankruptcy.

Thain had taken over as Merrill chief executive nine months before that weekend deal. Now, he appeared to be one of the few Wall Street leaders who grasped the enormity of the credit crisis. Thanks to his ­analytical approach to the marketplace, it seemed, ­Merrill shareholders could look forward to a stake in Bank of America.

“I have received thousands of e-mails saying, "Thank you for ­saving our company." Thain has said. And yet he admitted that the decision to sell Merrill Lynch, a 94-year-old institution that was always “bullish on America”, had been painful. “This was a great job. This was a great franchise. Emotionally, it was a huge responsibility.”

What was his personal reaction? “You can’t live through an event like this and not be changed,” he said. Before Merrill, Thain had gone from one success to another. He began his career at Goldman Sachs, where he rose swiftly through the ranks, then moved to the New York Stock Exchange, where he repositioned an outmoded ­institution for global growth.

He had been hired by Merrill to save the company from the mountain of subprime-­mortgage-related assets stockpiled by his predecessor, Stan O’Neal. But instead of saving the firm, he sold it to BofA. Or, from another perspective, he saved the firm by selling it.

But as the events of the next two months would show, despite what he told us that day, Thain had not been changed by his short and tumultuous tenure at Merrill. His 13 months at its helm and three weeks at BofA were to expose some blind spots. He appeared to be a man in a bubble, not good at listening to advice, and worse still at detecting changes of tone when it came to the public’s tolerance for corporate excess.

Even as he mused with us over the highlights of the previous year, the ground beneath him was eroding. Flashes of arrogance and misjudgment, not to mention the insubordination of his top lieutenants from Merrill Lynch, were becoming apparent to his new bosses at BofA, who were themselves keenly aware that the old Masters of the Universe banking model was done for. John Thain’s world had changed, even if he hadn’t.

John Alexander Thain was born in Antioch, ­Illinois, the son of a doctor. He excelled at ­Antioch Community High School, captained the wrestling team and served as the school’s valedictorian upon graduation.

The young man with ramrod posture and a head of thick, dark hair moved east at 18 to study electrical engineering at the Massachusetts Institute of Technology before earning a masters in ­business administration at Harvard. Upon graduation in 1979, he joined Goldman Sachs, working in corporate finance, then investment banking.

Mr Thain's rise at Goldman accelerated when he was selected to help launch a mortgage-backed securities division, reporting to Jon ­Corzine, who was then partner in charge of ­government, mortgage and money markets trading at Goldman’s fixed income group. Jon Corzine is currently the Governor of New Jersey. He was seriously injured in an automobile accident on April 12, 2007.

By 1990, Thain had risen to treasurer at Goldman and four years later, chief financial officer. In 1998, as chief executive, Corzine wanted to end Goldman’s partnership structure and take the firm public. In the internal ­dispute over this and other ­management issues, Thain, now presiding over the bank’s European operations, and several senior Goldman executives ousted ­Corzine, installing investment banker Hank Paulson as co-chief executive.

On the question of going public, Thain and his co-conspirators were on the wrong side of history: the firm’s initial public offering in 1999 ­enabled it to thrive over the next decade.

Even at Goldman Sachs, with a corporate culture of weeding out ­aging partners and promoting devotion to the firm over loyalty to individuals, Thain’s decision to turn on Corzine shocked many of his colleagues, enhancing a reputation for ruthlessness. A senior New York Fed official who worked with him in 1998, on the rescue of the failed hedge fund Long-Term Capital Management, describes Thain at that time as “a stone-cold killer”.

In 2003, Thain left Goldman to become chief executive of the New York Stock Exchange. His predecessor, Richard Grasso, had been ousted following a furore over his $187m pay package, and because he favoured maintaining the NYSE’s antiquated trading system. Thain forced the exchange to embrace electronic trading. His biggest achievement was to do what he’d initially resisted at Goldman and transform the “Big Board” into a public company.

Thain continued the company’s expansion by acquiring Euronext, a pan-European exchange. It successfully positioned the NYSE for global growth, as the results showed: in the two years after it went public, profits rose threefold. Seatholders at the old exchange, the owners of the 1,366 “seats” that confer the right to trade, reaped a bonanza when those seats were converted to shares.

Taking the NYSE public also helped Thain earn some $9m in 2006, a modest amount ­compared with the more than $100m he made over his career at Goldman. But more than the money, the NYSE experience proved that Thain could run a ­company on his own.

By 2007, Thain was anxious for a new challenge. It arrived seven blocks north-west of the NYSE, at the World Financial Centre headquarters of Merrill Lynch, where the investment bank was in the process of imploding. Under the leadership of Stan O’Neal, Merrill had boosted its earnings from $4.4bn in 2004 to $7.5bn in 2006, fuelled in part by the firm’s aggressive position in the market for securities backed by subprime ­mortgages so-called CDOs, collateralised debt obligations. But O’Neal’s profits came in the absence of any meaningful risk controls.

In a quest to keep boosting its income statement, Merrill bought subprime mortgage lender First Franklin in September 2006, at the height of the real estate bubble, for $1.3bn; in October 2007, the bank was forced to write down $8bn in losses on its dodgy assets, wiping out nearly a year’s profits.

O’Neal resigned six days later, and the company’s board launched a hurried search for a replacement. Among the candidates were acting co-chief executive Greg Fleming, who headed Merrill’s investment banking operations, and Larry Fink, chief executive of BlackRock, the massive asset management firm 49 per cent owned by ­Merrill.

According to a person involved in the selection process, Alberto Cribore, the lead director at Merrill, wanted Thain, the “Mr Fix-It” who had turned around the NYSE. The board moved quickly, and in November 2007, Merrill announced that Thain would become its 12th chief executive.

The new leader didn’t come cheap. When Thain joined Merrill in December 2007, he was awarded a signing bonus of $15m and an incentive plan tied closely to the value of Merrill shares, then worth some $68m. What Thain did not receive upon being named chief executive was a crash course in the art of internal company politics.

Merrill Lynch is best known in the US for being the brokerage firm that brought Wall Street to Main Street. After the second world war, the company aggressively courted retail investors across America, building a network of financial advisers that was unparalleled in terms of both assets under management and geographical reach.

Although the company soon expanded into investment banking and trading in the markets on its own account, it remained best known for its “thundering herd” of 16,000 financial advisers. It was also a “family friendly” firm, where sons followed in their fathers’ footsteps and personal loyalty trumped almost every other quality.

By 2002, when O’Neal took charge, Merrill was over-extended. O’Neal fired thousands of employees and campaigned against the “Mother ­Merrill” culture. As a result of O’Neal’s purges, many of the firm’s “culture carriers” departed, often acrimoniously. The talent drain was particularly apparent in 2006 and 2007, when Merrill dug itself into a huge financial hole. The Merrill Lynch that Thain took over in December 2007 was a shadow of its former self.

At first, Thain made the right moves, gathering allies quickly. In ­January 2008, he turned up at a conference of financial advisers in ­Arizona, pressed the flesh and declared his commitment to the thundering herd. ­Fleming, the head of investment banking who had survived the O’Neal era, pledged to help Thain from the start, joining him in an initial round of capital-raising.

Bob McCann, the street-smart leader of the thundering herd, also rallied round the new boss. It was hardly a holy trinity; however, Fleming and McCann weren’t close to each other, and they both kept a watchful eye on their new leader even while pledging loyalty.

Over time, some Merrill executives started to complain among themselves and to outsiders about a perceived arrogance in Thain. Indeed, a cult of personality had sprung up around him during his tenure at the NYSE. Although the Big Board is tiny compared with Merrill, it occupies a disproportionately large share of the national attention when it comes to US financial markets.

Thain’s success there triggered reams of glowing press reviews, including a profile in Institutional Investor magazine titled “The Adventures of SuperThain”. The hype mattered: Thain’s status helped him raise almost $20bn for a firm that had lost all credibility before his arrival. But some colleagues at Merrill felt all this had gone to his head.

Shortly after arriving, Thain hired two of his closest aides from the NYSE, chief financial officer Nelson Chai and com­munications director ­Margaret Tutwiler. Tutwiler’s ­philosophy, ac­­cor­d­ing to those who dealt with her, was to promote Thain as “the public face of Merrill Lynch”. That approach grated on some subordinates, who felt that no matter how hard they worked to turn the firm around, all the glory would accrue to one man.

In a Financial Times December 2008 interview, Thain admitted that he had underestimated the magnitude of the problems Merrill Lynch faced. At the time he joined, he told reporters that he didn’t plan to end the bank’s involvement in the already troubled CDO market, despite the $8bn in write-downs on those securities in the third quarter of 2007.

“I didn’t focus on this when I took over,” he told us. “I didn’t know how much the market was going to deteriorate over the course of the year.” He wasn’t alone. Thain’s generation of Wall Street leaders had never experienced anything akin to what lay before them in 2008.

It was only after the Fed brokered the sale of Bear Stearns, another famed Wall Street investment bank, to JPMorgan Chase in mid-March 2008 that Thain says he became alarmed. And yet, even in April, discussing Merrill’s first-quarter losses in the wake of Bear Stearns’ collapse, Thain told ­analysts he was staying the course. “We’re not pulling back from our fundamental strategy,” he said. “We’re not changing our view.”

Top lieutenants urged him to sell as many of Merrill’s toxic assets as he could, but colleagues remember Thain dismissing suggestions from below with a curt, “No, we’re not going to do that”. Throughout the spring and summer, Thain argued internally and to investors and regulators that Merrill was different from Bear, that the steady stream of fees generated by its thundering herd would protect it.

By early summer, however, with Merrill’s share price continuing to fall, there was no evidence of a turnaround. Despite this, Thain didn’t seem to grasp the gravity of some of his remarks. In a conference call in June 2008, for example, when discussing the possibility of raising capital, he mentioned that ­Merrill might sell its stakes in the Bloomberg publishing group or BlackRock.

Although he had vaguely raised such possibilities before, in the context of the conference call the remark came as a shock to BlackRock’s top executives, including founder Larry Fink. Over the next few weeks, BlackRock’s share price dropped by almost 25 per cent, enraging Fink.

By mid-July, Thain had abandoned the idea of selling BlackRock, but Fink and some of Thain’s top deputies had already begun to question his authority. At one meeting, Thain would insist that the trading desk “lighten up” the balance sheet. But a week later, no action would have been taken. Or Thain would turn down a request to hire a high-profile investment banker, but negotiations with the individual would still take place. ­

Making matters worse were Thain’s own high-profile hires. In the spring of 2008, ­Merrill announced that Tom Montag and Peter Kraus would join from Goldman Sachs. The size of the pair’s pay packages, $39m and $29m respectively, shocked Merrill executives who were preparing for pay cuts.

Merrill’s second quarter was a disaster, encompassing a $9.4bn write-down and a $4.6bn loss. It was obvious that the group would need more capital. Thain sold the bank’s investment in Bloomberg back to New York mayor Michael Bloomberg for $4.3bn, and accelerated an on-again, off-again plan to sell a big chunk of the firm’s CDOs.

On July 29, Merrill announced the sale of $31bn in CDOs to Lone Star Funds for $6.7bn. Just weeks earlier, the CDOs had been valued at $11bn on Merrill’s balance sheet. Merrill provided 75 per cent of the financing to make the deal happen, but it seemed worth it: with the sale, Thain had put Merrill’s problems behind him.

At the same time, the bank raised $8.5bn in new capital. It was a high-wire act that Thain pulled off with aplomb. “The CDOs were the source of the vast majority of losses at Merrill,” Thain told us in December. “There was a sense of relief. We had gotten rid of our most dangerous assets and we had raised capital.”

The relief was shortlived. Come September 2008, the market turned bearish, particularly towards Lehman Brothers, once regarded as the ultimate survivor. Richard Fuld, Lehman’s longtime chief executive, tried to halt the slide in his company’s stock price, announcing plans to put all of Lehman’s bad assets into a separate bank, a feat that would have taken months to pull off.

On the evening of Friday, September 12, 2008, after Lehman’s share price had continued to plunge, federal regulators convened Wall Street’s top bankers at the New York Federal Reserve to discuss the firm’s troubles. It was clear that Lehman had three stark choices: find a partner with which to merge, hope for a bailout, or collapse into bankruptcy.

On Saturday morning, Greg Fleming called his boss at home at around 7am. Given Lehman’s precarious situation, Fleming argued that Thain should start talking to BofA. The investment banking model was changing irrevocably and BofA was the best fit for Merrill: it was not a force in wealth management or international investment banking.

Merrill also ran the risk that BofA might buy Lehman if Thain didn’t act. Initially, Thain was unreceptive, he hadn’t reached one of the pinnacles of Wall Street only to cash in his chips from a position of weakness a few months later. Thain arrived at the New York Fed soon after. Within an hour or two, after New York Fed chief ­Timothy Geithner made it clear that Lehman wouldn’t be rescued, Thain called BofA’s chief executive, Ken Lewis, to ­initiate talks.

Asked whether he was pushed to call Lewis by either Geithner or then Treasury secretary Hank Paulson, the same Paulson he helped install as chief executive of Goldman Sachs a decade earlier, Thain said no. The Fed and Treasury “were initially focused on ­Lehman but grew concerned about us”, Thain said. “They wanted to make sure I was being proactive [but] they didn’t tell me to call Ken Lewis.”

For Lewis, who had climbed to the top of the US banking industry through acquisitions, Merrill was the ultimate prize. A deal could transform Bank of America from the McDonald’s of the industry into a financial services titan that would outstrip in size, know-how and reputation: Citigroup and JPMorgan Chase. Lewis said he’d fly to New York from the bank’s headquarters in Charlotte, North ­Carolina, and the two men would meet at BofA’s corporate apartment in the Time Warner Center at 2.30pm.

It was around lunchtime at the Federal Reserve, where meetings continued to take place. In the early afternoon, Morgan Stanley chief executive John Mack approached Thain. The men agreed to talk that evening. One competitor, spotting Thain and Mack in conversation, said that such a union would be like two drunks trying to prop each other up. Executives at Goldman Sachs also wanted to discuss an investment in Merrill, plus a line of credit.

That afternoon, Thain met Lewis ready to discuss the sale of a minority stake in Merrill Lynch. Lewis said he wanted to buy the entire company.

“I didn’t come here to sell the whole company,” Thain replied. Yet Thain recalls that as he and Lewis talked, the strategic logic behind a full deal became apparent. Bank of America was the dominant retail bank in the US, flush with consumer deposits. It was also a leader in the commercial banking business, where Merrill Lynch was weak.

Meanwhile, ­Merrill’s strongest unit, its 16,000 investment advisers, would fill a gaping hole in BofA’s product offerings. Merrill also wielded tremendous clout in the capital markets, where BofA was just a small player.

“The logic of it made a lot of sense to both of us,” Thain says. And yet he still didn’t like the idea of a deal. That evening, he and his two top Goldman hires, Montag and Kraus, met John Mack to discuss a deal with Morgan Stanley. But according to Merrill executives, by Sunday morning, Thain had dismissed the Morgan Stanley option.

Fleming, who was still pushing for a merger with BofA, was holed up at the offices of Wachtell Lipton, the bank’s law firm. He argued that BofA should move quickly to buy all of Merrill to prevent the events of the coming week from derailing the discussions. He pushed for a sale price in the high 20s or low 30s for Merrill stock, a significant premium over the $17 at which the shares had closed the previous Friday.

At the Fed that morning, Paulson laid it on the line with Thain: ­Merrill’s very existence depended on whether or not he could cut a quick deal. To more than one observer, Thain seemed shaken by the weekend’s events. For the New York Fed official who had described Thain as a “stone-cold killer”, the transformation of the Merrill chief executive over the weekend was remarkable. “He had lost his confidence,” the official said.

By Sunday afternoon, it was apparent that BofA would offer a rich price, $29 a share, to acquire Merrill Lynch. Selling the firm was not what Thain had been hired to do, but at least, given the cataclysmic market conditions, he’d got what seemed to be a good price. At 6pm, he convened a telephone board meeting to go over the details.

At 8pm, he rode up to Wachtell ­Lipton’s offices, on 52nd Street and Sixth ­Avenue, to sign the final agreement. A conference room was stocked with champagne, so that at around 9pm, Thain and Lewis could toast the deal. But both sides kept finding fresh details to iron out. When the two chief executives finally made their toast, around midnight, much of the ­bubbly was warm and flat.

On Monday September 15 2008, after Lehman Brothers had filed for bankruptcy protection, Bank of America announced the acquisition of ­Merrill Lynch in an all-stock transaction worth $50bn. When Thain ­convened a “town hall” meeting that afternoon to discuss the deal with Merrill Lynch employees, whatever misgivings he had about the sale were assuaged by the huge round of applause that greeted him.

Over the next few weeks, as some 200 BofA employees, members of a transition team, flocked to Merrill’s offices, Thain found himself managing a new relationship, with Andrea Smith, the human resources executive dispatched from BofA headquarters to serve as his shadow.

One of the key issues in the acquisition agreement concerned the payment of bonuses. By selling to BofA, Merrill’s executives knew that the days of multi-million-dollar bonus payments would come to an end. As a concession, in a non-public side-agreement, BofA allowed Merrill to pay out bonuses of about $4bn before the deal closed.

Neither Lewis nor Thain realised that this small amendment to the contract would eventually spark a state investigation ­requiring them and others to testify under oath about what they knew about the payments and when they knew it.

Shortly after the deal was announced, Thain made it clear to his future employers that he expected a bonus of $40m for putting Merrill together with BofA. That number came as a shock. In a long conversation, BofA’s chief administrative officer, J. Steele Alphin, urged Thain to revise the number downwards.

Alphin told Thain that BofA didn’t reward bankers simply for getting deals done, but for creating deals that worked over time. If Thain harbored any ambitions to succeed Lewis as chief executive of BofA, Alphin warned, a bonus of that size would undermine him with BofA’s board.

Thain agreed, reducing his bonus request over the course of the next two months. Following the creation of a $700bn government bailout fund for US banks, public disgust with multi-million-dollar bonuses and golden parachutes was more than apparent. In November, top executives at Goldman Sachs were the first to declare that they would not accept bonuses for 2008, even though they made a profit for the year.

Thain ultimately came to an understanding with Lewis that his own bonus would be lower than that of his new boss. Presuming that the BofA chief might get as much as $10m for his stewardship of the bank that year, Thain calculated that he deserved a similar, but slightly smaller sum for himself, especially for steering Merrill clear of the bankruptcy that befell Lehman.

On the morning of December 8, the day that Merrill’s board would meet to sign off on bonuses, the Wall Street Journal published a story indicating that Thain was planning to ask for as much as $10m. That afternoon, Thain recommended that neither he nor his top executives receive bonuses for the year.

The board did agree to $3.6bn in bonuses to be paid out to other ­Merrill Lynch executives. At BofA’s request, most of the money would be paid out in cash later in the month, before the deal closed. The early payment would actually reduce expenses for BofA in 2009, ­making it easier for the bank to hit its first-­quarter numbers.

Thain’s work for the year was essentially done. On December 19, he decamped with his ­family to their vacation home in Vail, Colorado, where they would spend the holidays. When the transaction closed on January 1, Thain, the 12th and final chief executive in ­Merrill’s 94-year ­history, was 1,700 miles away from the company headquarters in New York.

Before leaving for Colorado, Thain had negotiated a new title for himself: president of global banking, securities and wealth management at BofA. He would be responsible for planning and executing the merger of ­Merrill’s banking and trading business with that of BofA. In this portion of the deal, ­Merrill employees would emerge the winners, with thousands of BofA staffers laid off and replaced by their Merrill counterparts.

But in early January, signs of dissatisfaction towards Thain erupted within Merrill. McCann, head of the firm’s “thundering herd”, resigned. The news was no surprise to employees who attended the town hall meeting in September, just after the merger was announced.

In response to a question, Thain chided McCann for leaking a story to the press, then continued to rebuke him to such an extent that others were embarrassed. Following that encounter, Thain declined to promote McCann to the management level directly beneath him in the merged company, a slap in the face.

A few days later, Fleming tendered his resignation to accept a teaching position at Yale Law School, his alma mater. More than McCann’s departure, Fleming’s resignation caused concern about Thain in North Carolina. Fleming had been the prime mover behind the BofA merger, and was well liked in Charlotte. If Lewis had had any illusions about how some of Thain’s top deputies felt towards their boss, those illusions vanished.

On January 16, BofA and Merrill reported their fourth-quarter numbers. Merrill’s were disastrous: $21bn in operating losses, the worst ­performance in the bank’s history, even worse than the poor performances of Morgan Stanley and Goldman Sachs. Still, Lewis told listeners in a ­conference call that he was happy that Thain had joined the BofA ­management team.

Lewis had other problems. In early January, BofA’s share price sunk from $14 towards $10 per share. Shortly before the earnings announcement, it emerged that Lewis had lobbied the government in late December for an infusion of as much as $20bn in new capital, and a guarantee for some of Merrill’s weakest assets, in order to consummate the deal.

BofA’s stock price plunged into single digits, shareholders were outraged and ­several class-action lawsuits were filed, accusing Lewis of withholding important information prior to the December 5 vote to approve the Merrill deal. The bank issued a carefully worded statement saying that up until the second week of December, Merrill’s losses were in line with expectations.

A week after the earnings announcement, the FT published a story about early payment of the nearly $4bn in bonuses to Merrill Lynch employees. Outraged, Andrew Cuomo, New York State’s attorney-general, launched an investigation. Even though BofA executives had been actively involved in the timetable and payment of the bonuses, the bank sent a statement to the FT blaming Thain.

They had found the opportunity they’d been looking for: Thain would take the fall for bonuses and for as much else as they could lump on him. The BofA statement was a clear sign that the end was near for Thain. But in his office on the 32nd floor, the former chief executive didn’t seem to notice. He had just purchased 8,400 shares of his new company’s stock and was finalising plans for a forthcoming trip to Davos for the World Economic Forum.

Lewis flew up to New York on January 22 to fire Thain. While he was still aboard the BofA corporate jet, the purpose of his trip was disclosed in the media, along with the damning details of Thain’s $1.2m office redesign. On BofA’s trading floor in New York, where employees were angry about what the purchase of Merrill had done to their stock, a televised image of Lewis prompted a round of boos. ­Subsequently, the news that Thain was about to be fired sparked enthusiastic applause.

And so, just before noon, with all of Wall Street tipped off, the embattled Lewis fired the only executive in the organisation capable of replacing him at that moment as chief executive. It was a move designed for self-preservation in more ways than one.

Criticism of Lewis had reached ­deafening levels as it became apparent that he had overpaid for Merrill. Although Fleming was the prime negotiator on ­Merrill’s side of the transaction, it seemed as though Thain had got the better of Lewis during that frenzied September weekend.

In the wake of his firing when Thain apologised for the office redecoration and promised to reimburse the company, many of his former charges unburdened themselves about his failings, real and perceived. His supporters lashed back, blaming a venomous culture at Merrill that never embraced Thain as its new leader.

Was Thain the man in the bubble, brilliant at understanding the complex technical issues surrounding turn-of-the-century banking but deaf to the world beyond Wall Street, or even to dissenting voices in his own ranks? And if so, was he really so different from his peers?

On October 6, Richard Fuld testified before congressmen about the collapse of his bank, Lehman Brothers. In what amounted to an admission of Wall Street’s blindness towards the financial mess it created, he said: “Not that anyone on this committee cares about this, but I wake up every single night thinking, ‘What could I have done differently? What could I have said? What should I have done?’ And I come back to this: at the time I made those decisions, I made those decisions with the information I had. I can look at you and say, this is a pain that will stay with me the rest of my life.”

It was a speech more human than Thain has given. But then again, Merrill did not fail. It’s also the sort of speech the rest of Wall Street has yet to deliver even as it asks for billions more in taxpayer support.

Back in his office, the office that even some of his supporters feel betrayed by, John Thain is neither superhero nor the robotic demon he’s made out to be by detractors. He shows us a favourite item in the room.

For all the money lavished elsewhere by his designer, this, a painting from Steven Spielberg, cost nothing. It was a gift to commemorate Dreamworks Animation’s initial public offering in 2004 and it depicts the ogre Shrek alighting from a carriage with his bride, Princess Fiona. It’s not a castle they’re bound for: the pair are about to ascend the steps of the New York Stock Exchange.

Read more about the history of Goldman Sachs by reading the book, The Partnership: The Making of Goldman Sachs.

Source.

Gold could surge to $2,500 a troy ounce in the next five years because the prospects of either deflation or inflation were “becoming more extreme”, UBS said on Tuesday, March 10, 2009. The Swiss bank told investors to overweight gold in their portfolios.

The Swiss bank’s warning is the most radical among mainstream institutions and comes as some hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks.

“The current environment is one which can best be characterised as having a ‘low margin of error’ for central bankers, with the prospects for deflation or inflation becoming more ex­treme,” said Daniel Brebner, analyst at UBS in London.  A bet on gold is considered by some as essentially a bet against all paper currencies.

“Given the broad uncertainties in the current macro climate we believe investors should look to gold, given its historic tendency to act as a hedge,” the bank said. The bullish forecast failed to lift gold prices, depressed on Tuesday by lacklustre jewellery demand, traditionally the backbone of gold consumption, some profit-taking and an early rebound in financial stocks.

Spot gold in London was $896.5 a troy ounce in late afternoon trading on March 10, down from the previous days’ closing quote in New York of $920.95 an ounce. Gold prices hit a high of $1,030.8 last March and last month traded briefly above $1,000.

UBS, one of the biggest bullion dealers in London and Zurich, said the downside risks to gold prices were limited to about $500 an ounce, or less than 50 per cent below the current price, while the potential upside was $2,500.

Hedge funds that bet last year against investment banks are now betting against their ability to wea­ther the crisis without triggering a jump of inflation or letting the economy fall into deflation. Gold bulls include David Einhorn, founder of the hedge fund Greenlight Capital, who last year came under the spotlight for short selling shares in Lehman Brothers. Others looking at gold include Eton Park and TPG-Axon, investors said.

Source.