Too Big to Fail

by Andrew Ross Sorkin

  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 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 In
stitution.)

  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—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 under-stated—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 Blackfein, 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 sucess 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 GHW 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 Black-Rock, 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?”