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CEO Crisis at Citi and Merrill: How About a Crash Course in Risk?

The swift ouster and resignation of two powerful Wall Street CEOs within a week of one another shows there is a serious management void in the executive suite of financial institutions that went whole hog into derivatives tied to sub-prime mortgages.

The swift ouster and resignation of two powerful Wall Street CEOs within a week of one another shows there is a serious management void in the executive suite of financial institutions that went whole hog into derivatives tied to sub-prime mortgages.If CEOs are betting the ranch on risky derivatives (i.e., collateralized debt obligations) repackaged from bits and pieces of sub-prime mortgages to fuel their earnings, they ought to bone up on the mathematics underlying the pricing of these securities or make sure that their chief lieutenants - i.e. the chief financial officers - know what's going on.

The resignation yesterday of Charles Prince, CEO of Citigroup came a month after the bank reported a massive write down of $5.7 billion from losses in sub-prime mortgages. Citigroup expects to report additional losses in the range of $8 billion to $11 billion, according to yesterday's Wall Street Journal.

Prince's departure follows the forced retirement of Merrill Lynch CEO Stanley O' Neal after revising a third-quarter write-down on sub-prime-mortgage related securities to $7.9 billion, almost $3 billion more than the $5 billion originally estimated on Oct. 5.

In both cases, the higher write-downs are due to debt pools and mortgage securities on their balance sheets losing their value because of borrowers with shaky credit histories defaulting on their payments, leading to foreclosures and making it harder to price these instruments.

Because of CEO accountability, TowerGroup Global Research Fellow Guillermo Kopp, says it was time for these leaders to go. "Like Citi, several industry CEOs had to move on due to the subprime crisis and other market events," commented Kopp. "These changes at the helm reflect a mounting pressure by shareholders and investment clients for CEOs to steer through volatile markets and manage risk in an increasingly uncertain world," wrote Kopp in a commentary. "As the challenges in the financial services industry shift, the CEO office also requires a different management profile," he concluded.

Of course, it didn't help that Merrill's O'Neal fired the more experienced fixed-income trading team, which reportedly pointed out the risks of diving into sub-prime-CDO paper. Similarly, Citi replaced Thomas Maheras, a well-liked bond trader and co-head of the investment bank, left along with Randy Barker, head of fixed income, after Vikram Pandit, a former Morgan Stanley executive, was tapped to head trading, investment banking and alternative investments. The rest is history.

Because of the lack of talent in their upper ranks - probably the result of several purges and cost cutting campaigns - both companies are looking at outside candidates to fill the role. Both are said to be considering Laurence Fink, the CEO of Blackrock, the asset manager, who has risk management expertise in fixed income trading, and John Thain, CEO of NYSE Euronext, who has a degree from M.I.T. and a background in engineering.

The more serious issue that any successor will face is grappling with the risk management mess that has been left behind and the possibility of further deterioration. "The appetite for risk by large industry players varies, and a comparatively larger business footprint across diverse (businesses) was intended to give Citi a more balanced approach," commented Kopp. "Despite its larger size and strong momentum in certain business units, overall revenue growth at Citi lags when compared to other competitors," wrote Kopp. In other words, Citi took big risks but didn't "reap the business rewards and also its capital reserves didn't keep up with the risks in its business portfolio," Kopp added.

But the broader issue is whether Wall Street CEOs should have a more quantitative background or training in derivatives, to understand the risks they are taking. It's never a concern on the way up while they are making money, but with more losses looming from debt pools that are losing their value, it's something to think about on the way down. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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