[SOLVED] In December 2002, Stan O’Neal became

In December 2002, Stan O’Neal became CEO of Merrill Lynch & Co. Inc., the world’s largest brokerage house. Known as “Mother Merrill” to insiders, the firm had a nurturing environment that accepted lower profit margins so that veteran employees could remain with the firm. O’Neal changed that culture. He laid off one-third of the work- force—24,000 employees—and fired nine- teen senior executives while eliminating senior management perks. He put in a new young management team, expanded the firm’s overseas activities, and made Merrill a more aggressive, risk-friendly organization. In 2006, for example, the firm made
$7 billion in trading securities, compared with $2.2 billion in 2002. Under O’Neal’s leadership, Merrill became the most profitable investment bank in America, making more money per broker than any of its competitors. O’Neal was rewarded well— in 2007, he became one of Wall Street’s best-paid executives, earning $48 million in salary and bonuses.
He pushed the company into new lines of business, including investing in collateralized debt obligations (CDOs). Merrill led the industry in its exposure to CDOs. Over an eighteen-month period to the summer of 2007, its investment in these subprime mortgage-backed CDO pools rose from $1 billion to more than $40 billion. Then the subprime mortgage bubble burst.
The term subprime refers not to the interest rate changed on the mortgage but rather to the risk associated with the borrower. Subprime mortgages are given to high-risk customers who are charged an interest rate that is greater than prime. These mortgages are typically given to people who would not normally qualify for a mortgage from a conventional lender, such as a bank. From the lender’s point of view, as long as house prices increase, the risk of a loss on the mortgage is low. As such, the mortgages became low-risk, high-yield investments. The lenders of these subprime mortgages would then package these mortgages as bundles of asset-backed synthetic securities, such as CDOs, which were sold to third parties, including individuals, corporations, pen- sion funds, banks, insurance companies, and brokerage houses.
The subprime mortgage bubble bust when house prices in the United States began to fall. People could no longer refinance their homes or pay off their mort- gages by selling their homes. By late 2006, one in eight subprime mortgages was in default. Throughout 2007, nearly 1.5 mil- lion American home owners lost their homes. As the housing market imploded, mortgage payment defaults increased, and the value of subprime mortgages fell, as did the value of the subprime mortgage-backed CDOs. By the summer of 2007, sub- prime-related losses were being reported by all the major financial institutions.
In the third quarter of 2007, Merrill announced a loss of $2.3 billion, com- pared with a profit of $3.05 billion for the third quarter in 2006. It also announced a $7.9 billion provision for losses on mortgage-related investments, larger than the warning of a possible $5 billion write-down that it had made a month earlier. Within a week of reporting the largest quarterly loss in the company’s ninety-three-year history, O’Neal resigned as chairman and CEO of Merrill Lynch. Although he did not receive any severance, O’Neal did receive $161 million in stock and retirement benefits.
Questions
1. Subprime mortgages targeted lower- income Americans, new immigrants, and people who had a poor credit history. The customers were told that because house prices had been rising, the borrower would be able to refinance the loan at a later date with the increased equity in the house. Was this an ethically correct sales pitch? Were the lenders taking advantage of financially naïve customers?
2. O’Neal transformed Merrill Lynch from a conservative bank into an aggressive risk-taking institution. Risk taking means that there is the potential for high rewards as well as large losses. From 2002, when O’Neal became CEO, Merrill’s share rose 53%. Should the investors now be upset that, as a result of the subprime mortgage meltdown, Merrill’s stock price fell by about 30% in 2007?
3. As a result of the subprime mortgage debacle, the CEOs at Merrill Lynch, Citi- group, Bear Stearns, and Morgan Stanley all resigned or were fired. Their departure packages were $161 million, $68 million, $40 million, and $18 million, respectively. Are these settlements unreasonably high given the huge financial losses and write-downs that their companies recorded?

Question: In December 2002, Stan O’Neal became