Business Blog: Hoover’s Business Insight Zone

On this blog, October 24, 2007:

Merrill Lynch CEO Stan O’Neal better be glad that he’s been regarded more highly than Citigroup CEO Chuck Prince up to now, because Merrill’s horrific, embarrassing writedown of more than $8 billion in bad debt puts even Citi’s $5 billion-plus writedown to shame.

Ah, what a difference a couple of months makes! O’Neal was thrown out on his ear, Merrill hired John Thain to replace him, and now the firm expects to lose even more from bad debts:

Giant Write-Down Is Seen for Merrill

Merrill Lynch is expected to suffer $15 billion in losses stemming from soured mortgage investments, almost double its original estimate, prompting the firm to raise additional capital from an outside investor.

The article is worth reading, both to grasp the scope of Merrill’s problems and to get an idea of what Thain is doing to turn the tide — selling non-core assets, restructuring bonuses, and promoting teamwork, among other things.

We can hope — it may be vain, be we can hope — that future generations of bankers won’t make the risky gambles that Merrill (and its peers) made on mortgages, and that future CEOs will learn from the negative example of Stan O’Neal. Because for as bad as Merrill’s balance-sheet problems are, it’s the cultural problems in the firm that may be even more debilitating.

Countrywide has slid steadily toward the toilet over the past few months, notwithstanding the $2 billion infusion Bank of America gave it a few months back. Now BofA chief Ken Lewis is doubling down on his Countrywide bet — “doubling down” is the metaphor I’ve seen everywhere in the news stories on the deal — and the big (monster, ginormous) question remains:

Will the healthy part of Countrywide’s mortgage-servicing business — which Bank of America is buying at a steep discount — outweigh the gigantic subprime mortgage liabilities on its balance sheet?

My guess: no. But BofA will still come out more or less okay, since it’s frikkin’ huge and can absorb the hit.

But that doesn’t mean that Lewis was right to double down on a bad bet.

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For more, see this article (and video) from Mark DeCambre of TheStreet.com:

• BofA to Buy Countrywide for $4B

Our previous coverage on Countrywide:

• Mortgage problems are Countrywide.
• Countrywide prompts a heretical thought about CEO compensation.
• An appeal to Countrywide insiders: care to weigh in?
• Angelo Mozilo’s stock sales seem craven, but are they improper?
• Countrywide’s conniving ways?

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The other day a commenter took issue with a post of mine on an environmental topic; his comment included the assertion that “The climate-predicting models are flawed, and the science is rotten.”

You can read that comment thread for my specific reply, but here I’ll add my more general view that climate science has been far too politicized over the past three decades, which has led us down the fruitless path of debating climate science as a matter of conservative versus liberal views (or pro-corporate versus anti-corporate etc.), rather than allowing us to step back and think of climatic changes in truly scientific terms.

Whatever the case, the insurance business is surely taking climate change seriously, as reflected in this MarketWatch story:

Catastrophe losses reach $75 billion in 2007

LONDON (MarketWatch) — The insurance industry faced $75 billion of losses from natural catastrophes during 2007, up 50% from last year despite a lack of “megacatastrophes,” German reinsurer Munich Re said Thursday.

The losses rose from $50 billion in 2006, though this was still well short of the $220 billion reached in 2005 when Hurricane Katrina ravaged New Orleans and the U.S. Gulf Coast.

Still, the number of natural catastrophes tallied 950 this year, up from 850 in 2006 and the highest figure since 1974, when Munich Re began tabulating such events. . . .

The trend in respect of weather extremes shows that climate change is already taking effect and that more such extremes are to be expected in the future. We should not be misled by the absence of megacatastrophes in 2007.” . . .

“These events cannot, of course, be attributed solely to climate change, but they are in line with the pattern that we can expect in the long term: severe storms, more heavy rainfall and a greater tendency toward flooding, including in Germany,” said Peter Hoppe, head of Munich Re’s geo risks-research department.

Put it another way: Munich Re doesn’t care what I think about climate science. They don’t care what a blog commenter who calls the science “rotten” thinks about it. They care about what they see in their underwriting books. And what they see, from a financial point of view, is sustained effects from climate change.

The great question about the promotion of Vikram Pandit to the head of the table at Citigroup is whether “new CEO” equates to “new direction” for the mammoth bank.

I am one of many who thinks that Citi needs a new direction — one less beholden to Sandy Weill’s vision of consolidation, one more beholden to getting the most out of an incredibly huge array of assets.

In the words of this BusinessWeek story, Pandit has placed his emphasis on “improving productivity, positioning the company for the future, and fostering key talent.” This is a good start.

1. Productivity: Citigroup has been getting less out of more than its peers, and efforts to streamline the bank went sloooowly under former CEO Chuck Prince.
2. Positioning for the future: I’ve argued before, parroting Jack Welch, that the hard work of management is to balance the short-term versus the long-term. That’s especially a challenge for Citi, which hasn’t been doing too great on either front.
3. Fostering key talent: Along with the balance of short and long term, this is the other term in the Grand Unified Equation of business leadership. The fact that Chuck Prince (and, even more so, Stan O’Neal at Merrill Lynch) failed at this was a hallmark of the lack of leadership during his tenure.

Pandit has his work cut out for him. It will be interesting to see whether he’s up to the job, especially if that means carving Citigroup into pieces.

Bill Miller’s* message to Citigroup: Don’t bring in a new CEO to launch a new strategy. Bring in someone who can simplify and execute instead — like Mark Hurd has done at Hewlett-Packard.

Bill Miller’s simple plan for Citi

. . . He said the bank should find someone who has a similar management style to Hewlett-Packard CEO Mark Hurd. Hurd replaced Carly Fiorina in 2005 and has led a dramatic turnaround at HP, mainly by cutting costs and focusing the computer company on what it does best.

In other words, Miller said he does not want to see Citigroup bring in someone who would have a radically different vision for the company, even though it has been hit hard by the subprime mortgage crisis.

“I would like someone to run Citi like the way that Hurd saw HP - someone to come in and simplify the processes. That’s key. Someone who would approach Citi that way would be great,” he said. “Citi doesn’t need a major strategic overhaul.” . . .

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Related posts:

• How good was Carly Fiorina at Hewlett-Packard?
• Putting out fires versus fireproofing.
• Floyd Norris and Chuck Prince: a follow-up.
• The importance of execution.

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* Miller is a rock-star fund manager for Legg Mason.

As they seek diversification, plenty of money managers are investing in “frontier markets” — i.e. stock exchanges in developing countries. Some of these markets, like those in Vietnam, are especially appealing because they aren’t heavily tied (or “geared”) to U.S. stock exchanges. In other words, they don’t go up or down in lockstep with the bigger bourses of the world.

For more, check out this interesting Marketplace interview (posted in both text and audio) with John Authers, investment editor of the Financial Times:

Prospecting in ‘frontier markets’

One of the things that has driven the emerging markets and which has helped countries like Brazil or Russia truly emerge, at least on some measures, is the huge booming commodity prices. If you’re a mineral-rich, or in other ways commodity-rich country in that band in southern Africa there are ways in which you could become a frontier market. Obviously you need to make some extremely careful decisions about the political system. There could be some very interesting bargains to be found there. You obviously have to do an awful lot of due diligence first.

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You could be forgiven for forgetting Morgan Stanley these days, what with all the hubbub surrounding other financial players like Citigroup, Bear Stearns, and Merrill Lynch. But Morgan Stanley made headlines this week when it fired Zoe Cruz, a 25-year veteran of the firm who was the head of its trading operations — and who was one of the highest-placed women on Wall Street.

This Wall Street Journal story gives the inside-baseball account. Note the lowlights of Cruz’s combative management style:

How Zoe Cruz
Lost Her Job
On Wall Street

Zoe Cruz appeared to be surviving the credit crisis that has roiled Wall Street. But the Morgan Stanley co-president’s response in the aftermath of the firm’s $3.7 billion in losses helped fuel her ultimate fall.

The 52-year-old executive didn’t take personal responsibility for the losses at Morgan Stanley, according to people familiar with the firm, and instead lashed out at fellow employees in a series of meetings about the losses, raising questions about her management style.

As a result, Morgan Stanley Chief Executive John Mack lost confidence in Ms. Cruz, whom he had repeatedly backed in the face of opposition from senior executives, these people say.

Among other criticisms leveled at Ms. Cruz: She didn’t have a good handle on the risks the firm took in its mammoth bond division, a business she had grown up in and built over the years, and she frequently clashed with well-liked veteran investment banker Robert Scully, often publicly correcting him at employee presentations.

. . .

Even before the mortgage-trading losses surfaced, Ms. Cruz’s leadership style was an issue. Some bankers and traders still resented her support for former CEO Philip Purcell, who was ousted in 2005 after a campaign against him by a group of Morgan Stanley alumni.

After Mr. Mack backed Ms. Cruz upon his return to the firm, he thought he could help Ms. Cruz improve her management style, and a personal coach was retained to work with her, people familiar with the firm said. But she didn’t always display harmonious team work with her co-president, Mr. Scully, sometimes contradicting him in presentations.

This puts me in mind of two things:

1. The very best performers, in my experience, are always ready to take responsibility for what happens around them. Good CEOs do it. Harry Truman did it when he said “The buck stops here.” Jerry West and Michael Jordan did it on the basketball court. And we could proliferate examples beyond that. What all of these exemplars display is the same mindset that drives Fernando Flores, a remarkable business consultant who refuses to accept excuses from himself or anyone else. I encourage you to read this Fast Company profile on Flores, written nearly a decade ago.

Talk all you want to, Flores says, but if you want to act powerfully, you need to master “speech acts”: language rituals that build trust between colleagues and customers, word practices that open your eyes to new possibilities. Speech acts are powerful because most of the actions that people engage in — in business, in marriage, in parenting — are carried out through conversation. But most people speak without intention; they simply say whatever comes to mind. Speak with intention, and your actions take on new purpose. Speak with power, and you act with power.

Cruz would have benefited from that kind of high-integrity, high-trust approach with her colleagues — and with herself.

2. It’s amazing how people — especially high-performing ones like Cruz — can’t see their own weaknesses, or can’t see how to get around them. The tippy-top performers I was just talking about? They figure out how to correct for their weaknesses, how to eliminate them or, even better, simply take them off the table. You would think that someone as unquestionably smart as Cruz would come to realize that, simply on the level of personal politics, she would be better served to bite her tongue than to lash out at colleagues. I’m not even talking about coming around to a truly empathic appreciation of other people (although I certainly would recommend that to anyone). I mean that, from a strictly selfish viewpoint, Cruz would have been better served to do a better job of keeping up appearances.

Citadel chief Ken Griffin has emerged as a major financial player in the past few years. He’s a math whiz, and he’s well known for his hard-charging ways. So there’s something vaguely comical when you find out that this financial “barbarian” sits in his office reading management books about building emotional intelligence and connecting on a personal level with his employees. But at least you can credit him for trying, becuase he’s self-critical enough to understand that for Citadel to grow like he wants it to, he has to open up some cracks of humanity in his hard-shell personality.

Maybe Cruz will get a chance to do that in the next phase of her career. But if she’s like most of us, she’ll continue not to take responsibility for what happened to her at Morgan Stanley.

This Deal Journal interview with author/professor Lawrence Mitchell intrigues both the business journalist and the historian in me:

Welcome to America, Home of “The Speculation Economy”

DJ: But part of the success of America has been its ability to innovate with finance.

LM: A tiny, tiny fraction, less than 3%, is for new offerings. The rest is secondary trading. If we’re not financing productivity, what are we financing? You start to see this sort of second-order level of remove from production and industry, of finance taking on its own independent logic, where money is moving from one pocket to another but not landing any place where it’s making any difference.

DJ: So we’re in danger of falling down the rabbit hole of finance?

LM: I’m deeply worried that unless we pay attention to restoring a basic balance to our economy, and redirecting finance to its original goal – which was to finance productivity – then we’re going to find ourselves in the long term in very bad shape.

So now I’ll just be scurrying out to lay hands on Prof. Mitchell’s book.

Not to harsh your Friday afternoon, but this sobering piece from David Gaffen touches on several interesting (read: potentially horrifying) connections between the credit crisis per se and other parts of the financial world.

Containment Has Failed

Wrapping one’s arms around the depth and breadth of this credit crisis remains a difficult thing, if only because it seems to require bigger arms every week. Every other day or so, another analyst determines that such-and-such bank will lose exponentially larger sums of money than the last; another economist has a larger estimate of writedowns or losses and how much of a hit the economy will take as a result. . . .

The upshot:  could be bad economic times ahead.  And once again I’ll repeat my prognosis that we’re a ways from seeing the end of this yet. I think we’re going to see more failures of largish firms before we’re done.

I’ve been meaning to post about this column, which recaps the 1980s-era spate of Wall Street innovation on behalf of middle-class investors, then decries the way that Wall Street now seems to have abandoned these same customers — or has, at least, left them much more to their own devices.

Wall Street doesn’t want you

. . . even the stunning size of these [recent] losses [e.g. at Citigroup] is not going to turn Wall Street’s attention back to the individual investor or saver. The best minds of Wall Street are going to continue to put their time and effort elsewhere, because Wall Street is still convinced that’s where the money is. Investors with a few hundred thousand or even a few million in assets, even if that represents the work of a lifetime, can’t expect more than a passing thought from the giants of finance.

That’s so profoundly wrong that it makes my hair — what remains of it — stand on end. That Wall Street would want to abandon financial innovation for the middle class just as the baby-boom generation hits its peak earning and saving years is beyond comprehension to me. And that it would call quits to a revolution in financial services and products for the middle class just halfway through signifies a profound failure of imagination.

Maybe Wall Street is just too intent on building ephemeral empires such as Citigroup and Bank of America (BAC, news, msgs) to care about these opportunities. But not everyone can be Goldman Sachs, nor should everyone aspire to.

Jubak’s suggestions for what financial services companies could be doing for middle-class customers are interesting, even if I differ with some of his points of focus. (E.g., I’m not sure how banks would help workers whom the global economy renders “permanently unemployable.”)

Bigger picture: there’s always room for innovation, and not just in the obvious areas (telecom, biotechnology, computing), but in all areas of business. It would be great if the financial services giants woke up from their collective/risk hangover and decided to serve the middle-class market better.