O'Neal, Merrill Lynch, and Boards

Via a PR person, I heard from Ron Garonzik, vice president of leadership talent at Hay Group, a New York-based consultancy. He thinks that Merrill Lynch's board is making a mistake in naming a board member as even an interim CEO.

The fact that its Board has appointed a board member -- a non-executive chair -- is indication of the absolute breakdown of its accountability of ensuring business continuity for Merrill’s most critical management positions. The success rates of outside CEO hires are grim: it is well documented that the chances of getting the boot of a forced resignation are much higher for external CEO hires as compared to insider hires (by 20 percentile point or more for North American companies).

That certainly squares with what I've heard over the years. Plus, if a company develops candidates internally, it isn't at the economic mercy of someone from the outside who already probably has a good deal and whose personal fiscal future now has to be guaranteed under what are now more questionable circumstances.

I did take some exception to the idea of a breakdown of the board's accountability, but Mr. Garonzik did have a good explanation:

The breakdown in accountability isn’t about the stopgap measure of appointing an interim CEO – but rather that fact that no credible successor is waiting in the wings to take over from O’Neal. As if things weren’t bad enough with Merrill’s name being dragged through the mud with investors, and that they have to deal with the negative publicity concerning O’Neal’s departure package. On top of all that, they have to deal with the uncertainty of not having a pair of steady hands at the helm of a venerable “Wall Street” firm. That alone is evidence of the board’s failure to meet it’s accountability of ensuring business continuity.

Now here's where the board really fell down. When O'Neal was coming up through the ranks, so were a number of other people. But the CEO got rid of much of Merrill's old guard - and potential successors, or challengers. The board allowed him to do this, which really was foolish. The evidence is that the board evidently had to consider a short-gap measure and someone from the outside to follow. A company with a well-developed succession plan always has someone who could reasonably well take over.

Unfortunately, this isn't going to be an issue just for Merrill Lynch. Investors are calling for the head of Citigroup's Charles Prince. Does that company have talent ready to go? And if New Jersey Institute of Technology finance professor Michael Ehrlich is right, structured investment vehicles - the class including the securitization of mortgages - could still face another $30 billion to $50 billion in losses. According to this from a press release:

The SIV rescue attempt, led by JP Morgan, Citibank, and Bank of America with US Treasury Dept encouragement, will not stop the losses, Ehrlich said. The SIV bailout fund known as the Master-Liquidity Enhanced Conduit (M-LEC) will, at best, slow down losses because there is no Federal bailout money in the plan.

"The fundamental market mispricing of the real estate and also the credit risk markets will be corrected," said Ehrlich. “In the best case, the M-LEC might forestall a panic leading to an over-correction in pricing. Unfortunately, there is likely to be the unintended consequence that the M-LEC will discourage new capital from flowing into this market.”

That leaves the question of the red ink or the blood on the water will spill faster.

Finance and the Roll of the Dice

From the what-were-they-thinking, department, we have the latest insanity at Merrill Lynch. A big producer of the securitized mortgage deals, the company has already written down $8.4 billion in two clumps. The powers that be there talked about some number of billions, and then almost doubled it two week later. CEO Stanley O'Neal has made a public mea culpa, but as one analyst on NPR said Friday night, they should have warned everyone the minute they knew, and not delayed.

Now, according to the New York Times, O'Neal floated the ide aof a merger with Wachovia without talking to Merrill's board - which would mean a sale at a low point of the stock, forcing the shareholders to bail out management - and the board is ready to fire him. It's certainly drama, but how about the culpability of the board? Was there no oversight? Did they ever ask about the degree of risk the institution was taking on a regular basis? I realize that such things can be difficult for a board to uncover. AFter all, it's getting the numbers from management, and given how difficult it apparently was for many to understand just how shaky some of the assets were, they probably would have essentially said, "All is well."

But at this point, it's obvious the even the largest and most respected corporations are capable of screwing up on a level that is almost inconceivable. Everyone in the business community should remember that capitalism is essentially the combination of two activities: gambling and mitigation. You take risks to make more money, and then you try to minimize the downside and the possibility of an explosion. But as I quoted from a commentary, many people in these institutions never face the essential instability of statistically unlikely activities that happen on a regular basis.

Or, as someone in risk management recently told me, there was the head mathematician in a financial business he once worked for. There was some big loss, and the CEO said, "What can we do to keep this from ever happening again?" The mathematician said, "Sell refrigerators." When you can calculate demand, pretty well know your costs and what you can get, you can make safer decisions. But you won't make as much money. The CEO of that company had forgot that they are gamblers, and, apparently, people at Merrill, and virtually all other financial institutions and investors, have been forgetting that as well.

More Credit Fall-Out

I don't have a lot of time today, but here's some round-up of the ongoing credit crisis - which, I think, it really an economic crisis because while Alan Greenspan might think the worst is over, I suspect he's talking strictly of liquidity issues. The impact on consumers and, therefore, business has got to last for years, unless lenders go back to the same risky behaviors that got us here in the first place, and that would be tragic, simply compounding the impact farther down the line.

• Deutsche Bank's investment bank unit is expecting "a third-quarter pre-tax loss of up to €350m (£242m), after €2.2bn of charges relating to leveraged loans, structured credit products and trading," according to the Financial Times. That's about $493 million in loss and almost $3.1 billion in charges in US dollars, according to the XE.com conversion calculator.


• The same article said that Merrill Lynch's fixed income trading practice will see a loss of $1.5 billion in the third quarter. The company has sacked the heads of fixed-income trading and structured credit products. Sounds like scapegoating to me - the company got greedy, didn't exercise oversight and prudence, and now wants to blame someone.


• Bears Sterns is cutting its workforce by another 310 jobs.


• The European Central Bank is keeping its interest rate at 4 percent, while the Bank of England is staying at 5.75 percent. Although I'm far from an expert in high finance and economics, I'd wonder if this might influence the Fed to not go for another rate drop, the expectation of which, according to analysts, is fueling the renewed optimism (notice I'm not saying strength) in the U.S. stock market. If so, a surprise could spell an unpleasant drop in the the DOW and NASDAQ by November.


• According to another FT story (love that paper), a McKinsey Global Institute study suggests that "[g]lobal financial markets face a permanent shift in power from traditional money managers to opaque groups such as petro-dollar investors, Asian central banks, hedge funds and private equity groups." Their holdings apparently represent 5 percent of the world's financial assets. If current trends continue, that could become three-quarters the size of the global pension markets. That's influence and power among people who are out of the reach of global regulation.

The big story, I think is the last one. There are seismic shifts in business as usual. The entire global financial structure is undergoing a restructuring in reasonable assumptions and perceptions. That is going to affect how every company has to consider its financing options, which means reconsidering its business.