01 Dec 2009
Hope for Reform DimsTopics:
A year after the federal government rushed to rescue Wall Street from its own nearly fatal excesses, former Merrill Lynch CEO John Thain (MBA ’79) worries “that we aren’t using the crisis to make necessary regulatory reforms.” In a freewheeling Q&A session with some 400 students in Burden Hall on September 30, Thain advocated action on three fronts:
- consolidating the six federal agencies that regulate financial institutions to eliminate overlapping and duplicative jurisdictions
- significantly raising capital requirements — the cushion against losses — for all financial institutions
- creating a mechanism to deal with those institutions regarded as too big to fail
Thain characterized the crisis as a classic bubble “fundamentally fueled by monetary policy” that held interest rates too low for too long, stoking excessive consumer and corporate debt. “Regulatory structures failed to keep up” with innovations in the marketplace, he added.
Thain took the top spot at Merrill Lynch in December 2007, resigning as CEO of the NYSE Euronext. Previously, he spent most of his career at Goldman Sachs, where he rose to president and COO.
Thain labeled as “nonsense” the frequently heard claim in Washington that executive pay plans, particularly lavish bonuses, spurred the excessive risk-taking that ultimately led to the financial meltdown. He advocates pay plans that reward executives for long-term performance, provide for claw-backs when investments go sour, and give executives significant equity stakes in their companies. “Two firms with compensation plans like I just described, Bear Stearns and Lehman Brothers, both failed. So having the right compensation systems didn’t help them avoid the crisis,” he added.
By contrast, he continued, not enough attention has been paid to improving risk management. Risk models widely used before the crisis relied too heavily on historical data that turned out to be flawed, he said. Most models, for example, assumed continued home price appreciation, and some explicitly barred consideration of home price depreciation. “You have to have multiple views on risk management, including views that are out of the box,” said Thain.
Of all the government’s actions since the crisis erupted in September 2008, the biggest mistake was allowing Lehman Brothers to go bankrupt, he declared. “That caused the credit markets worldwide to seize up. The system went into a state of shock.”
With Lehman’s abrupt demise, Thain suddenly faced the possibility that his own troubled firm, Merrill Lynch, could be next. “To protect the employees and shareholders, I initiated a process that led to Merrill’s acquisition by Bank of America,” he recalled. Three weeks after the deal closed on January 1, 2009, Thain was forced to resign as controversy swirled around the generous terms of the $50 billion deal and $3.6 billion in year-end bonuses paid to Merrill employees.
Asked whether he felt like a scapegoat, Thain took the high road. “I still think the acquisition will be a good deal for Bank of America. It’s unfortunate how it was all handled.”
On the day Thain spoke at HBS, Bank of America CEO Ken Lewis unexpectedly announced his retirement, effective December 31, amid continuing investigations and shareholder lawsuits over his bank’s acquisition of Merrill Lynch.
Class of MBA 1979, Section G