Bull Bust

A Financial Times analysis has found that Merrill Lynch's losses over the past 18 months are equal to a quarter of the profits (adjusted for inflation) made in its 36 years as a listed company. This little fact is a compelling statement on the severity of the credit crunch, and on the continuing vulnerability of major financial firms.

On this measure, Merrill Lynch is by far the sickest patient of the crisis. The FT article cited an issue I discussed recently, the failure of the integrated banking model, as a major factor in Merrill's meltdown. Complex structured products and cheap leverage created a massive securitization business that produced record profits over the past decade.

But, much like UBS, Merill Lynch's core competency was never investment banking. Its brokerage business was the bread and butter of "Mother Merrill". As Merrill swelled, so did its reliance on securitization and cheap internal credit to fuel profits. As the typical story goes, when the market crashed Merrill was left holding billions in worthless assets. It ditched the girl it brought to the dance for the most popular girl in the room, and when the music stopped, it was left alone in the parking lot.

Stan O'Neal at Merrill was one of the chief protagonists of what has been called the "gung-ho, risk-taking culture" that ruled Wall Street and the City of London. Since O'Neal's departure, John Thain has struggled to pick up the pieces, and every time Merrill looks like it may be turning a corner, another massive writedown is taken. Merrill is a prime example of the excesses, poor risk-management, and lax oversight the defined the past decade in finance.

The discussion on Merrill offers me the chance to briefly revise my earlier discussion on the death of the financial supermarket. My previous post neglected to focus on the lax management and regulation that is really to blame for the credit crunch. Securitization went wild because it was allowed to. Perverse incentives, reckless monetary policy, and a regulatory orthodoxy that fuelled (rather than tempered) asset bubbles created the music to which Chuck Prince and others kept "dancing". Risk management became virtually non-existent.

The integrated-banking model does not inherently promote reckless lending and risk-taking. Financial firms will always expand (irrationally, no doubt) into new, profitable, and complex businesses. But a regulatory environment that stems the inevitable excesses before they infect the financial system and real economy will go a long way towards breaking the practices that contributed to the current crisis.

FYI: Stan O'Neal received a reported $159 million golden parachute upon his firing. Not bad for ruining one of the largest financial firms in the world...