Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the FinancialSystem--and Themselves

CHAPTER SEVEN

On the afternoon of June 11, Greg Fleming, the disarmingly youthful-looking forty-five-year-old president of Merrill Lynch, was meeting with clients at the firm’s headquarters when his secretary quietly slipped him a note marked “Urgent.” Larry Fink, chief executive of the investment management behemoth BlackRock, was on the line and needed to talk.

Fleming couldn’t imagine what might be important enough to justify the interruption, but given the commotion in the market, he agreed to take the call. Rumors that morning claimed that BlackRock might be a candidate to buy Lehman Brothers; Fink had only encouraged the speculation by appearing on CNBC earlier that day and declaring: “Lehman is not a Bear Stearns situation. Lehman Brothers is adequately structured in terms of avoiding a liquidity crisis.”

The two executives were close—Fink, a fifty-five-year-old financier, had lent Fleming and his banking team office space after the September 11 attacks drove Merrill employees out of their downtown headquarters—and their two firms were now partners, as Fleming had helped broker a 2006 deal to merge Merrill’s $539 billion asset-management business with BlackRock in exchange for a stake of nearly 50 percent in the firm. The deal had vaulted BlackRock, long known as a bond house, into the $1 trillion-asset club and had established Fink, who had helped create the mortgage-backed security market in the 1980s, as an even more influential power broker on Wall Street.

“What the fuck is going on?” Fink, nearly breathless with anger, screamed into the phone as soon as Fleming greeted him. “Just tell me what the fuck is going on! How could he do this? How could he do this to me?”

“Larry, Larry,” Fleming tried to calm him, “what are you talking about?”

“Thain!” Fink bellowed, referring to John Thain, Merrill Lynch’s chief executive. “CNBC says he’s putting BlackRock on the block. What the fuck is he thinking?”

“Larry, I know nothing about it,” Fleming replied, genuinely baffled. “When did he say this?”

“In a speech! Today he announces to the whole world that the stake is up for sale. What fucking idiot does that?” Fink shouted, still at the same pitch of fury.

“I didn’t know John was giving a speech, but—”

“We have a lockup, Greg! You know that; John knows. He has to ask my permission. He hasn’t called me—nothing! He has no fucking right to sell BlackRock!”

“Larry, I know we have a lockup agreement. Just take a deep breath and listen,” Fleming urged him.

“Think about it,” Fink continued. “What seller announces to the world he’s selling? Just think about the stupidity of this.”

“As far as I know, no one at Merrill wants to change the relationship we have with you,” Fleming replied. “BlackRock is a strategically critical asset for us. Let me find John, find out what happened, and the three of us will talk this out,” he promised, and ended the conversation.

The only speaking engagement of Thain’s of which Fleming was aware had taken place the previous day, at a conference hosted by the Wall Street Journal; in it, he had made no notable mention of BlackRock. Indeed, Fleming had been impressed with Thain’s objective assessment of the state of the industry during his talk. “Everyone is shrinking their balance sheet. There was too much leverage in the system, too much credit, for too long,” Thain had said, assuming the role of the industry elder statesman. “We all have concerns about what we read in the papers.”

Fleming called Thain’s office but was told that he was away. Fleming knew that Merrill’s balance sheet had continued to deteriorate—it was loaded with subprime loans the company had been unable to get rid of, and it likely needed to raise more money. But Fleming didn’t expect that Thain would actually want to sell BlackRock, which many considered Merrill’s most solid asset. Announcing a sale would only put more pressure on Merrill.

Like Lehman Brothers, Merrill had been struggling with its own crisis of confidence. For the past several months, Thain had repeatedly told investors that the firm had marked—or valued—its assets conservatively and wouldn’t need to raise additional capital. But investors had been skeptical, knocking Merrill’s shares down 32 percent for the year.

Thain, Paulson’s former number two at Goldman Sachs, had been brought in to run Merrill just seven months earlier to help restore some semblance of order after the firm reported its biggest loss in history and ousted its chief executive, Stan O’Neal. At the time, Larry Fink actually thought he was the top candidate for the job, only to find out by reading the New York Post’s Web site that he had lost out to Thain. His own job interview was supposed to have been later that week, which might explain some of his frustration with Thain.

An ultra-straitlaced executive who was sometimes referred to as “I-Robot,” Thain had appealed to Merrill’s board because of his newly minted reputation as a turnaround artist. After rising rapidly through the ranks at Goldman, he left to overhaul the New York Stock Exchange after the extravagant compensation package for its CEO, Richard Grasso, caused an outrage. Fink, ironically, had led the exchange’s search committee that selected him. At the NYSE, Thain (who, perhaps not surprisingly, took a post-Grasso $16 million pay cut) unleashed a radical transformation, shaking the world’s largest stock exchange out of its clubby, anachronistic ways. He cut perks—shutting the wood-paneled Luncheon Club and firing the exchange’s barber—and turned the exchange into a for-profit, publicly traded company. He took on the powerful, entrenched constituency of floor traders and specialists, who protested in vain as Thain dragged them into the electronic trading age.

Thain, who had grown up in Antioch, Illinois, a small town just west of Lake Michigan, had always been considered a talented problem solver. In his junior year at the Massachusetts Institute of Technology, when he interned at Procter & Gamble, he made a simple but highly significant observation of an assembly line he was supervising. The workers were making Ivory soap, and whenever technical problems forced the line to come to a halt, they would wait for it to start up again before getting back to work. The college boy persuaded the workers that there was no reason to stop—they could keep making soap and stack the boxes on the side until the line came back on. That way their bonuses, which were based on production, would not be affected. Thain won them over, especially after he pitched in and stacked boxes himself.

While his public image as a callous technocrat may not have been entirely fair, Thain did have his weaknesses. With an engineering background, he could come across as a purely linear thinker who sometimes seemed remarkably tone deaf. “When he made conversation, he would explain the things in detail to almost the point that I didn’t know what the hell he was talking about,” Steve Vazquez, one of his peers from high school, said. At a meeting at Goldman in 1999, Thain told a roomful of bankers and lawyers, “Would it hurt you to suck up to me once in a while?” He thought he was being funny; others couldn’t tell.

The incident that had so enraged Fink turned out to be just another example of his tin ear, as Fleming ultimately discovered. Thain had been taking part in a conference call with Deutsche Bank investors when Michael Mayo, the analyst running the call, asked him, “So, I think you said before that you’re comfortable with BlackRock and Bloomberg. Is that still the case? Under what circumstances would you say it doesn’t make sense to have those investments anymore?”

Thain, reasonably enough, took the question to be a hypothetical. Of course Merrill needed to look at all its assets and figure out which ones could be turned into cold, hard cash, he said; in this environment, any investment bank needed to do that. “At the end of last year when we were looking to raise capital, we looked at various options, which included selling common, selling converts,” Thain replied. “But also included using some of the valuable assets that we have on our balance sheet, like Bloomberg and BlackRock.

“And if we were to raise more capital, we would continue that process of evaluating what alternatives we had and what made the most sense for us to do from a capital efficiency point of view.”

Thain’s answer might have made plenty of sense to himself, but having heard him repeatedly say, “We have plenty of capital going forward,” investors took it as a not-so-subtle hint, and the damage was done. Within seventy-two hours, Merrill was being described “as the most vulnerable brokerage after Lehman.”

For a single day John Thain had the job that he had wanted for his entire career: to be the CEO of Goldman Sachs. That day, unfortunately, was September 11, 2001. As the company’s actual CEO—Hank Paulson—was on a plane headed to Hong Kong when the attacks took place, Thain, the firm’s co-president, was the most senior executive at 85 Broad Street, Goldman’s headquarters, and somebody had to take control. (His other co-president, John Thornton, was in Washington, D.C., for a meeting at the Brookings Institution.)

Thain had always been certain that his destiny was to run Goldman himself one day. Over the Christmas holiday of 1998, he had taken part in—perhaps even instigated—the palace coup that forced Jon Corzine out and put Hank Paulson in charge of Goldman. At Robert Hurst’s Fifth Avenue apartment, Thain and Thornton had agreed to support Paulson. But they thought they had received an informal promise in exchange: Paulson said he planned to be the CEO for only two years as a transition until he could move back to Chicago, and then they expected the job to be bequeathed to them. With Corzine off skiing in Telluride, Colorado, they made their pact.

For Thain, a longtime lieutenant and friend of Corzine, it was a heart-wrenching decision, but backing Paulson—whom he genuinely believed would make a better leader than Corzine—enabled him to advance his own career. As the person closest to Corzine on the executive committee, Thain was the one to have to break the news to him, and he was forced to watch as his boss fought back tears. Goldman partners, many just back from vacation, received a terse e-mail from Paulson and Corzine on the morning of January 11, 1999: “Jon has decided to relinquish the CEO title.”

But after two years passed, Paulson showed no interest in stepping aside as he realized how much work he still had to accomplish and was unsure about whether his successors were up to the task. Thain, like any senior Goldman partner, had become outrageously wealthy, accumulating several hundred million dollars in stock from the IPO, but he realized that his boss wasn’t going anywhere soon, and his dream of running Goldman would remain just that. Thain and Paulson got along well, but there was now an underlying tension. Thain resented the fact that Paulson hadn’t stuck to what he thought was their agreement, while for his part, Paulson questioned whether Thain, whom he respected as a talented financier, had the sound judgment to be CEO. He was also bothered by Thain’s un-Goldman-like displays of wealth. Though Thain was in many ways understated—he never appeared in the society pages, for example—he bought a ten-acre property in Rye and owned five BMWs. Paulson was also irked by Thain’s vacation rituals: While normally a hard worker, Thain was always determined to take a two-week trip to Vail at Christmastime, a week over Easter, and then another two weeks in the summer. For a perpetual worker like Paulson, it was a tough pill to swallow. By 2003 it was clear to both Thain and Thornton that Paulson wasn’t going anywhere. Thornton, who by then had grown frustrated he had not been elevated, decided to leave. Soon after his departure, he took Thain out to dinner.

“You can’t rely on Hank’s previous words,” Thornton said. “If I were you, I’d be getting out of here.”

Only several months later, Paulson appointed a former commodities trader named Lloyd Blankfein to be co-president with Thain. The ascension of Blankfein, who was building his own power base at the firm, not just politically but through sheer profits, as he oversaw business that accounted for 80 percent of Goldman’s earnings, was a sure sign to Thain to begin looking for an exit.

Paulson was speechless when Thain marched into his office to tell him he was leaving to become CEO of the New York Stock Exchange. Thain subsequently went on to deserved success in the position.

Four years later, with the credit crisis deepening in the fall of 2007, several large banks started taking huge losses and firing their CEOs. Thain was a natural candidate for firms looking for an upgrade. (Indeed, he had been considered for the position not just at Merrill Lynch but also at Citigroup, along with Tim Geithner.) He debated with himself—and with his wife, Carmen—about whether he would take the Merrill job if it was offered to him. He had done his own due diligence on the firm’s books and was satisfied that, despite the roughly $90 billion in shaky loans and derivatives on its balance sheet, it was manageable. But more than that, he saw it as an opportunity to be a CEO of a major brokerage firm—to get the job he had never landed at Goldman. Given his contacts and reputation, he also saw Merrill as a platform from which he could beat Goldman at its own game. He judged the effort to be at least a five-year project; he told Merrill’s board it would take him two years to fix the balance sheet and another three to take the firm to the next level. He eventually accepted the position and was paid a $15 million signing bonus and a $750,000 annual salary. The board also granted him options that would amount to another $72 million if he could bring Merrill’s shares above $100; they rose 1.6 percent to $57.86 on the news that Thain would come on board but still had a long way to go for that bonus to kick in.

As soon as he arrived, he moved quickly to shore up Merrill’s capital base, hoping to move a step ahead of the problem. His frame of reference was the end of Drexel Burnham Lambert, Michael Milken’s firm, which had filed for bankruptcy in 1990. “The demise of Drexel was really a liquidity problem,” he said at one of the firm’s Wednesday-morning risk-committee meetings, explaining how the firm didn’t have enough cash on hand. “Liquidity is the most important thing.” In December and January, Merrill raised $12.8 billion from the sovereign wealth funds Temasek Holdings of Singapore and the Kuwait Investment Authority, among other investors.

At the same time, he went about dismantling the O’Neal empire. When he first arrived, he noticed that the security guards at Merrill’s headquarters just across from Ground Zero always kept an entire elevator bank open exclusively for him. Thain walked over to one of the other elevators, and the moment he entered, all the employees shuffled out. “What’s the matter, why are you getting off ?” he asked. “We can’t ride the elevator with you,” the employees told him. “That’s crazy, get back in here,” he said, as he instructed security to open up the elevator bank for everyone. He also went about slashing costs by selling one of the firm’s G-4 planes and a helicopter. No target was too small: The freshly cut flowers that were costing the firm some $200,000 a year were replaced with silk ones.

At the same time—in a paradox that was not lost on his staff—Thain began spending serious money on talent. In late April, with the approval of Merrill’s board, he hired an old friend from Goldman, Thomas K. Montag, as his head of trading and sales. To lure him away, the firm agreed to a signing bonus of $39.4 million, even though Montag wouldn’t begin work until August. In May, Thain would hire Peter Kraus, another Goldman man, whom he guaranteed a $25 million golden parachute.

And then there was his office. He and his wife had decided it was badly in need of a renovation. O’Neal’s white Formica furniture didn’t match the rest of the Merrill decor, and an adjacent conference room had been turned into O’Neal’s personal gym, complete with an exercise bike and weights. Thain hired celebrity interior decorator Michael S. Smith (whose clients included Steven Spielberg and Dustin Hoffman) to renovate his office, the adjoining conference space, and the reception area, including repainting, carpentry, and electrical work. Thain didn’t pay much attention to the details, focusing mainly on the fact that Smith had happily brought over his favorite desk from his old office at the NYSE. But Smith billed the firm $800,000 for his services and submitted an itemized list of goods that included an $87,000 area rug, a $68,000 credenza, and a $35,115 commode. The executives in the billing department who cut the checks, however, were so aghast at such profligacy that they made copies of the receipts, which they would later use against him.

For all Thain’s efforts to improve morale, he seemed to be achieving precisely the opposite. On the trading floor, “39.4”—a sly reference to Montag’s bonus—became a popular way to punctuate a sentence instead of using an expletive. While Merrill executives praised Thain for his prescient efforts to raise capital, there were grumblings that, as a manager, he was either too much of a micromanager or more likely the opposite, too detached. When he hired a new chief of staff, May Lee, he neglected to mention it to certain of the firm’s top inner circle. On her first day on the job, she took her seat at an executive committee meeting with all of them. Robert McCann, who ran the firm’s brokerage business, walked into the room, noticed the stranger, and looked at Thain quizzically. “Oh, I probably should have told you,” Thain said matter-of-factly, “this is my new chief of staff.”

He also rankled some executive committee members with his grandiose media appearances, in which he cast himself as the great savior of Merrill. He brought in Margaret Tutwiler, a former State Department spokeswoman in G. H. W. Bush’s administration, to run communications. Within the firm some thought he might be angling for the Treasury secretary post if John McCain, the Republican front-runner, was victorious.

By that June 11, when Larry Fink made his enraged call about BlackRock, it had become clear that the capital that Merrill Lynch had raised from Temasek and KIA, the sovereign wealth funds, back in December, was still insufficient—and that those deals were proving to be much more expensive than they appeared at the time. Under their terms, the investors were entitled to additional payouts to compensate for any dilution in their holdings if Merrill issued new shares at a lower stock price. Merrill’s stock price, meanwhile, had slid steeply. To add $1 billion in new capital, the firm might actually have to raise an amount nearly three times that to compensate the 2007 investors. Thain could also see that the second quarter was shaping up to be worse than the first, though he didn’t know how bad it would ultimately be.

Merrill’s problems were by now becoming evident to others on Wall Street, feeding a perception that Thain did not have a solid grasp on the firm. As the banking analyst Mayo told Thain on the conference call that got him in trouble with Fink: “It’s kind of ‘Raise as you go’ is the perception, as you have the losses, you raise more capital. Maybe it’s more of a perception of the industry, if you disagree. At what point do you say let’s just get far ahead of anything that could come our way?”

“I don’t agree with the way you characterized it,” Thain replied. “We raised $12.8 billion of new capital at the end of the year, we only lost $8.6 billion. We raised almost 50 percent extra and so we did raise more than we lost. The same actually was true at the end of the first quarter, we raised $2.7 billion, versus the $2 billion we lost. So we have been raising extra.”

But that would not be enough.

Several weeks after Merrill’s board had named Thain CEO, he was faced with an especially delicate task. Placing a call to his predecessor, Stan O’Neal (who had just negotiated an exit package for himself totaling $161.5 million), Thain asked if they might get together. Hoping to keep their meeting out of the newspapers, the two decided on breakfast in Midtown at the office of O’Neal’s lawyer.

After a few pleasantries, O’Neal stared levelly at Thain and asked, “So, why do you want to talk to me?”

Thain knew that if there was one person in the world who could explain what had gone wrong at Merrill Lynch, why it had loaded up on $27.2 billion of subprime and other risky investments—what, in other words, had gone wrong on Wall Street—it was O’Neal.

“Well, as you know, I’m new, and you were the CEO for five years,” Thain said carefully. “I’d like to get your take, any insight on what happened here. Who everybody is, and all that. It would be very helpful to me and to Merrill.”

O’Neal was silent for a moment, picking at his fruit plate, and then looked up at Thain. “I’m sorry,” he said. “I don’t think I’m the right person to answer that question.”

O’Neal was out of a different mold than most of Merrill’s top executives, not least of all because he was African American—quite a change from the succession of white Irish Catholics who had headed the firm in the past. His was, by any measure, an amazing success story. O’Neal, whose grandfather had been born a slave, had spent much of his childhood in a wood-frame house with no indoor plumbing on a farm in eastern Alabama. When Stan was twelve, his father moved the family to a housing project in Atlanta, where he soon found a job at a nearby General Motors assembly plant. GM became Stan O’Neal’s ticket out of poverty. After high school he enrolled at the General Motors Institute (now known as Kettering University), an engineering college, on a work-study scholarship that involved his working six weeks on the assembly line in Flint, Michigan, followed by six weeks in the classroom. With GM’s support he attended Harvard Business School, graduating in 1978. After a period working in GM’s treasury department in New York, he was persuaded in 1986 by a former GM treasurer, then at Merrill Lynch, to join the brokerage firm on its junk bond desk. Through hard work and support from powerful mentors, O’Neal rose rapidly through the ranks. He eventually came to oversee the junk bond unit, which rose to the top of the Wall Street rankings known as league tables. In 1997 he was named a co-head of the institutional client business; the following year, chief financial officer; and in 2002, CEO.

The firm for which O’Neal was now responsible had been founded in 1914 by Charles Merrill, a stocky Floridian known to his friends as “Good Time Charlie,” whose mission was “Bringing Wall Street to Main Street.” Merrill set up brokerage branches in nearly one hundred cities across the nation, connected to the home office by Teletype. He helped democratize and demystify the stock market by using promotions, like giving away shares in a contest sponsored by Wheaties. More than the mutual fund giant Fidelity or any bank, Merrill Lynch, with its bull logo, became identified with the new investing class that emerged in the decades after World War II. The percentage of Americans who owned stock—whether directly or indirectly, through mutual funds and retirement plans—more than doubled from 1983 to 1999, by which point nearly half the country were investors in the market. Merrill Lynch was “Bullish on America” (an advertising slogan it first used in 1971), and America was just as bullish on Merrill Lynch.

By 2000, however, the “thundering herd ” had become the “phlegmatic herd”—a bit too fat and complacent. The firm had gone on a shopping binge in the 1990s, accelerating its global expansion and swelling its workforce to 72,000 (compared to the 62,700 of its closest rival, Morgan Stanley). Meanwhile, its traditional power base, the retail brokerage business, was being undercut by the rise of discount online brokerage firms like E*Trade and Ameritrade. And because much of Merrill Lynch’s investment banking business was predicated on volume, not profits, the dot-com crash in the stock market the previous year had left Merrill vulnerable, exposing its high costs and thin margins.

The man tasked with shrinking Merrill back to a manageable size was O’Neal. Although colleagues had urged him to proceed slowly, especially in light of the trauma of 9/11, in which Merrill had lost three of its employees, O’Neal plowed ahead with little regard for the effects of downsizing on the firm’s morale and culture. Within a year, Merrill’s workforce had been cut by an astonishing 25 percent, a loss of more than 15,000 jobs.

“I think this is a great firm—but greatness is not an entitlement,” O’Neal remarked at the time. “There are some things about our culture I don’t want to change … but I don’t like maternalism or paternalism in a corporate setting, as the name Mother Merrill implies.”

The management turnover that accompanied his ascension was likewise startling: Even before he officially became chief executive in December 2002, almost half of the nineteen members of the firm’s executive committee were gone. It became clear that O’Neal would force out anyone whom he had any reason to distrust. “Ruthless,” O’Neal would tell associates, “isn’t always that bad.”

If a colleague dared stand up to him, O’Neal was famous for fighting back. When Peter Kelly, a top Merrill Lynch lawyer, challenged him about an investment, O’Neal called security to have him physically removed from his office. Some employees began referring to O’Neal’s top-management team as “the Taliban” and calling O’Neal “Mullah Omar.”

As well as by vigorous cost cutting, O’Neal had plans to make Merrill great again through redirecting the firm into riskier but more lucrative strategies. O’Neal’s model for this approach was Goldman, which had begun aggressively making bets using its own account rather than simply trading on behalf of its clients. He zealously tracked Goldman’s quarterly numbers, and he would hound his associates about performance. As it happened, O’Neal lived in the same building as Lloyd Blankfein, a daily reminder of exactly whom he was chasing. Blankfein and his wife had come to jokingly refer to O’Neal as “Doppler Stan,” because whenever they’d run into him in the lobby, O’Neal would always keep moving, often walking in circles, they thought, to avoid having a conversation.

O’Neal did force through a transformation of Merrill that, in its first few years, resulted in a bonanza. In 2006, Merrill Lynch made $7.5 billion from trading its own money and that of its clients, compared with $2.6 billion in 2002. Almost overnight, it became a major player in the booming business of private equity.

O’Neal also ramped up the firm’s use of leverage, particularly in mortgage securitization. He saw how firms like Lehman were minting money on investments tied to mortgages, and he wanted some of that action for Merrill. In 2003 he lured Christopher Ricciardi, a thirty-four-year-old star in mortgage securitization, from Credit Suisse. Merrill was an also-ran in the market for collateralized debt obligations, which were often built with tranches from mortgage-backed securities. In just two years Merrill became the biggest CDO issuer on Wall Street.

Creating and selling CDOs generated lucrative fees for Merrill, just as it had for other banks. But even this wasn’t enough. Merrill sought to be a full-line producer: issuing mortgages, packaging them into securities, and then slicing and dicing them to CDOs. The firm began buying up mortgage servicers and commercial real estate firms, more than thirty in all, and in December 2006, it acquired one of the biggest subprime mortgage lenders in the nation, First Franklin, for $1.3 billion.

But just as Merrill began moving deeper into mortgages, the housing market started to show its first signs of distress. By late 2005, with prices peaking, American International Group, one of the biggest insurers of CDOs through credit default swaps, stopped insuring securities with any subprime tranches. Ricciardi, meanwhile, having built Merrill into a CDO powerhouse, left Merrill in February 2006 to head a boutique investment firm, Cohen Brothers. With his departure, Dow Kim, a Merrill executive, sought to rally those who stayed behind on the CDO front. Merrill, he promised, would maintain its ranking as the top CDO issuer, doing “whatever it takes.” One deal Kim put together was something he called Costa Bella—a $500 million CDO, for which Merrill received a $5 million fee.

But Jeffrey Kronthal, a Merrill executive who had helped recruit Ricciardi to Merrill, had been growing increasingly concerned that a storm was threatening not just extravagant projects like Costa Bella, but the entire CDO market, and he began to urge caution. He insisted the firm maintain a $3 billion ceiling on CDOs with subprime tranches. Kronthal’s wariness put him directly in the path of O’Neal’s ambition to be the mortgage leader on Wall Street—a situation that was clearly untenable. In July 2006, Kronthal, one of its most able managers of risk, was out, replaced by thirty-nine-year-old executive Osman Semerci, who worked in Merrill’s London office. Semerci was a derivatives salesman, not a trader, and had had no experience in the American mortgage market.

Despite its ongoing management turmoil, Merrill Lynch kept ratcheting up the volume of its mortgage securitization and CDO business. By the end of 2006, however, the market for subprime mortgages was perceptibly unraveling—prices were falling, and delinquencies were rising. Even after it should have recognized an obvious danger signal when it was no longer able to hedge its bets with insurance from AIG, Merrill churned out nearly $44 billion worth of CDOs that year, three times the total of the previous year.

If they were worried, however, Merrill’s top executives didn’t show it, for they had powerful incentive to stay the course. Huge bonuses were triggered by the $700 million in fees generated by creating and trading the CDOs, despite the fact that not all of them were sold. (Accounting rules allowed banks to treat a securitization as a sale under certain conditions.) In 2006, K im took home $37 million; Semerci, more than $20 million; O’Neal, $46 million.

In 2007, Merrill kept its foot firmly on the gas pedal, underwriting more than $30 billion worth of CDOs in the first seven months of the year alone. With his bets paying off so incredibly well, though, O’Neal had overlooked one critical factor—he hadn’t made any preparations for an inevitable downturn, having never paid much attention to risk management until it was too late. Merrill did have a department for market risk and another for credit risk, though neither reported directly to O’Neal; they were the responsibility of Jeffrey N. Edwards, the chief financial officer, and of Ahmass Fakahany, the chief administrative officer, a former Exxon financial analyst and an O’Neal favorite.

Before long, however, the fault lines started to show. Kim, who oversaw the mortgage division, announced in May that he was leaving the firm to start a hedge fund. Responding to doubts voiced by some of their colleagues that the firm’s strategy could be sustained, Semerci and Dale Lattanzio became defensive. On July 21, at a meeting of the board, they insisted that the firm’s CDO exposure was nearly fully hedged; in a worst-case scenario, they maintained, the firm’s loss would amount to only $77 million. O’Neal stood up and praised the work of the two executives.

But not everyone agreed with that optimistic assessment. “Who the fuck are they kidding? Are you fucking kidding me with this?” Peter Kelly, Merrill’s outspoken lawyer, asked Edwards after the meeting. “How is the board walking away without shitting their pants?”

As market conditions worsened, it became clear that the metrics they were using had no grounding in reality. Two weeks after the July board meeting, Fleming and Fakahany sent a letter to Merrill’s directors, briefing them on the firm’s deteriorating positions.

O’Neal, meanwhile, became withdrawn and brooding, and began to lose himself in golf, playing thirteen rounds, often on weekdays and almost always alone, at storied clubs like Shinnecock Hills in Southampton.

Merrill’s CDO portfolio continued to plummet through August and September. In early October, the firm projected a quarterly loss of roughly $5 billion. Two weeks later, that figure had ballooned to $7.9 billion. Desperate, O’Neal sent an overture to Wachovia about a merger. On Sunday, October 21, he had dinner with Merrill’s board, and in discussing options to solidify the firm’s balance sheet, he mentioned he’d talked to Wachovia. Somewhat prophetically, he told them of the market turmoil. “If this lasts for a long period, we and every other firm that relies on short-term overnight and term repo funding will have a problem.” But the board did not focus on that last point. They were furious he had engaged in unauthorized merger talks. “But my job is to think about options,” he protested. Two days later the board met without him and agreed to force him out. Few were sympathetic. A former co-worker told the New Yorker: “I wouldn’t hire Stan to wash windows. What he did to Merrill Lynch was absolutely criminal.”

One morning in late June, New York’s mayor, Michael Bloomberg, left his brownstone apartment on Seventy-ninth Street, hopped into the back of his black Suburban, and headed to Midtown for a breakfast date. With his security detail waiting outside, Bloomberg, wearing his usual American flag lapel pin, strolled into New York Luncheonette, a tiny diner on Fiftieth Street across from a parking lot, and greeted John Thain. The restaurant was one of Bloomberg’s favorites; he had recently brought a long-shot presidential hopeful, Barack Obama, there.

Although Bloomberg didn’t know Thain very well personally, he had had a long and fruitful association with Merrill Lynch, which had supported his eponymous financial-data company since its inception. Bloomberg, who had been a partner at Salomon Brothers, the bond-trading powerhouse, and was in charge of the firm’s information systems, started his terminal business in 1981; Merrill, which helped finance it, was the first customer to buy one of his machines, which delivered real-time financial data for traders. In 1985, Merrill acquired 30 percent of Bloomberg LP for $30 million, though it later reduced its stake by a third.

When Michael Bloomberg became mayor of New York, he placed his 68 percent stake of the company into a blind trust and stepped away from managing it—even if, in reality, it was closer to a half-step, especially when it came to critical company matters—like the one John Thain was about to broach. Thain, desperate for more capital and sufficiently convinced after the Larry Fink debacle that he should try to keep the firm’s BlackRock stake, wanted Bloomberg to buy back Merrill’s 20 percent holdings in his company. If the mayor declined to make the purchase, however, it was unclear whether Merrill would have the right to sell its share on the open market. The contract had been written in 1986 and they both knew it was murky.

Tucked away in a corner booth, the two men sipped coffee and chatted amiably. As former bond traders and ski enthusiasts, they hit it off surprisingly well.

“We’d probably be looking to do this over the summer,” Thain said, trying to remain somewhat noncommittal so as not to convey any sense of panic. Within half an hour, they had an agreement to move forward.

It was the lifeline he had been hoping for, and as soon as he bid the mayor farewell, Thain raced back to the office to tell Fleming to start work on the project immediately.