Cause of Financial Problems: Merrill Lynch - Case Study Example

Cause of Financial Problems: Merrill Lynch Affiliation Credit crisis was a major contributor to the financial crisis that led to the second greatest ever known global recession. Most financial institutions, especially the Wall Street, are said to be the root cause as they were involved in fraudulent engagements, greed and lacked good management and advice. The following essay will evaluate one of the affected companies, Merrill Lynch, as the effects led to its downfall and resulted in being bought by the Bank of America. It will also identify the causes of the problem the institution faced as well as the probable solutions that would have prevented the underlying issues that led to its demise. Introduction A credit crisis is a predicament that transpires when various financial institutions offer or are sold high-risk loans that begin to default. Usually, when borrowers fail to pay their loans, due to whatever reasons, the financial institutions that provided the loans stop getting payments. The situation is followed by a phase in which financial institutions start redefining the risk level of their borrowers, which makes it hard for debtors to get creditors. Usually there three major contributors to a credit crisis, in which, the banks either pay too much for the received securitized loans, or do not charge enough interest on loans, or the rating system does not measure the risk of the loans properly. A credit crisis, therefore, transpires when various factors coalesce in the marketplace, affecting a huge number of financiers. On the other hand, a financial crisis is a circumstance in which the value of assets or financial institutions drops at rapid rate. The crisis is usually connected to a run or a panic on the banks, whereby, investors withdraw their money from savings account or sell off their assets with the anticipation that the value of those assets will fall if they stay put at a financial institution. A financial crisis can occur because of assets or institutions being overrated, and can be intensified by an investor’s behavior (Birkner, 2009). The 2007-2008 global financial crisis threatened many financial institutions such as Merrill Lynch. Merrill Lynch is a wealth management segment of the Bank of America based in Manhattan. The company was one of the leading financial institutions whose client assets was worth $2.2 trillion and housed over 15 000 financial advisors up until its collapse in 2008 which saw it are bought by the Bank of America. The company’s downfall was as a result of poor management, rational decision making, overspending and fraud, employment of incompetent employees as well as the belief that the company was too big to fail. Management The overall company’s management, especially after Mr. E. Stanley O’Neal was made the chief executive of the company, was not as perfect as one would have expected it to be. Although O’Neal remains as the most intriguing persona in Wall Street due to his rise from a General Motors line to top international financial institution, he was quite competent given his roots as a grandson of a former slave. The company’s management was poor in that only the top management and the executive persons were in a position to make the final decisions of any steps to be taken by the company. In this case, some of the decisions that were made by Mr. O’Neal were materialized despite being opposed by some. There was also too much turnover especially if anyone tried to oppose any decisions that the company’s chief made. For example, one of the executives, a trader Jeff Kronthal challenge to Mr. O’Neal was met with hot anger and, consequently, dismissal (Birkner, 2009). The executive had claimed, when answering about his firing Kronthal, that dysfunction on Wall Street is a good thing. The entire management of the organization led to its eventual downfall because even after the dismissal of O’Neal and John Thain was made the company’s chief executive, it did not stop it from falling. Decision Making The company had an issue when it came making decisions. Considering that it was one of the leading financial organizations in the world, one would have expected it to have a sound decision making team, rather, most of the decisions made preceding its failure were rational. First, it was Mr. O’Neal’s decision to purchase the First Franklin mortgage beginning franchise and associated servicing proposal from National City Corporation. The terms of the agreement, included the Merrill Lynch mandate to pay a $1.3 billion acquisition value for San Jose, Calif.-based First Franklin Financial Corporation, as well as its joint business units Nation Point, City Home Loan Services and Inc. Frank Franklin was one of the top inventors of prime-residential mortgage loans through a wholesale system. The idea to purchase it appeared like an ideal deal but turned out to be a complete disaster. First Franklin was one of the dominants of the sub-prime industry, which at the time; the industry was still in a phase of boom. On top of acquiring First Franklin, Merrill also took exposure in Freedom Mortgage, a UK sub-prime mortgage company (Chen & Fong, 2012). Its decision to acquire more than four various sub-prime companies was considerably rational, given that they did not know what future the companies held. The previously limited if any exposure company now had become their major bet with paying top dollar for First Franklin and the rest. Consequently, the company was stuck with loans valued at billions of dollars that were dysfunctional, that is, the borrowers had defaulted. The effect was enormous in that the defaulted loans weighed heavily on the company and led to its ultimate downfall since it had no expertise in the type of field it had gotten itself into. In addition, one of the major contributors to a sound decision making is involvement of every employee within organization. It not only helps employee to feel a sense of belonging, but also presents the final decision makers with a variety of multiple perspectives from its workforce. Merrill and Lynch appears to have lacked that as even the executives received cold responses from the chief executives whenever they tried to challenge the senior’s moves. Being independent when making major and crucial decisions by O’Neil was one of the leading factors that caused its stability. Some issues that involved collateralized debts obligations (CDO), synthetic CDOs and credit default swaps would have better been handled if the leader had embraced other people’s opinions regarding the same (Chen & Fong, 2012). Over spending, greed and Fraud The company was involved in a lot of unethical behaviors that saw it get hefty fines from the authorities. For example, before the realization of the collapsing state of the company, its chief executive was said to have had acquired for himself an office rug valued at over $80 000. Moreover, although the CEO must have heard or anticipated the organization’s failure, the rug was considered a bit too expensive. In addition, the executive’s greed saw them arrange for themselves a bonus payment of about $3.6 billion in 2008, a rather bad season to do so as the world was undergoing a financial crisis. Moreover, the bonus release was made way before its regular time of issue and was taken from the Fed’s TARP bailout (Flynn, 2008). Another ethical issue involved discrimination charges in which the company had fired one of its workers based on his ethnicity. Merrill Lynch received a $1.6 million fine for compensating the fired employee. The company was also involved in other fraudulent behaviors in its accounts such as a case about the alleged Nigerian energy barges than never happened. The case and a misleading research released by the company saw it receive hefty fines, which contributed to the many causes that led to its failure. Incompetence Come of Merrill’s employees proved to be incompetent, which usually resulted in many turnovers as they proved to lead the company to a much worse state than it should have been. For example, Mr. Osman Semerci, who the chief executive and his team had placed in charge of making money from the CDOs proved to know just how to underwrite the investments. He, however, did not have the idea on how to protect the organization from possible losses. Another level of incompetence is by is former chief executive, Mr. O’Neil, who until towards the end he became aware of how badly the company was fairing (Flynn, 2008). It indicates a level of ignorance in that he did not know of the company’s position of failure, yet he was its overseer. In addition, there are other cases that involve its employees with fraudulent accusations and ethical issues, which portrays of the firm’s incapability to uphold competence. Company size beliefs There is usually that notion that people believe that companies that are big are not in a position to fail, based on their size. The likelihood of the poor performance as well as the general collapse of Lynch may have some connections with such believe, which usually make people, employees and bosses included, to over trust a company’s strength (McGeehan, 2004). Since Merrill is an international company, and had only but always reported continuous growth, its enormousness provided its employees and probably the firm’s advisers with a sense of security due to its size. In most cases, people believe that it is difficult for the government to watch a big company fall and, hence, they usually intervene and offer help whenever such organizations are faced by a threat. Therefore, laxity caused by such faiths played some part since no one thought that the company would come down, as big as it was. How the problems would have been avoided In terms of management, the company should have employed a system whereby everyone’s opinions and contributions mattered despite their level, especially if it involved crucial matters. The system would have prevented the unnecessary firings as well as grow the company. The company’s rational decision-making would have been prevented if they had a well laid out protocol to be followed during any decision making. It would have been even better if it involved every employee to participate, in which it would not only have offered the top executives with various insights and viewpoints, but also, a sense of worth by the employees. Out of the over 60 000 employees the company have, some of them would have offered a better angle of the decisions made. On the other hand, since most of the greed, the top people in the organization carried out fraud and overspending cases, if the company had initially set up system that involved regular checkups on their functions, such cases would have been minimal to none. Out of the regular follow-ups would have identified the underlying issues the company faced, and consequently resulted to their handling, thus, preventing any huge damage. In terms of incompetence, if the company had emphasized on recruiting competent leaders as well as kept them under regular evaluation, the likelihood of them lowering their competence bar and laxity would have been avoided. Finally, the company needed information and the knowledge that anything is possible, even a failure of a top company like it. The lack of that knowledge is what made most of the employees to, especially the executives, to loosen their grip on ensuring that the company performed well and maintained its high competence. Conclusion In conclusion, the firm’s failure can be said to have been caused by numerous reasons, some of the great while others small. However, the Bank of America’s decision to purchase it was a good move that at least is was not completely diminished, considering that it was one of the oldest and biggest financial institutions. Nonetheless, it would be advisable for other organizations to learn from this case as well as try to reform some of their managerial performance to ensure their survival in such periods. Financial institutions should also have correct regulatory systems and advisors to enable them and ensure they make the right decisions when faced by predicaments. Lastly, since financial institutions play a major role in a country’s economy, the government should ensure that they are kept under surveillance at all times to prevent recession or depression issues as experienced in 2007-2008. References Birkner, C. (2009). Merrill to pay $39.8 mil. Futures: News, Analysis & Strategies For Futures, Options & Derivatives Traders, 38(5), 12. Chen, Z., & Fong, W. M. (2012). WAS THE WRITING ON THE WALL? AN OPTIONS ANALYSIS OF THE 2008 LEHMAN BROTHERS CRISIS. Journal Of Investment Management, 10(4), 91-102. Flynn, S. (2008). Put the devil in the bottle. International Financial Law Review, 27(10), 17. McGeehan, P. (2004, October 13). Problems at Lending Unit Put Merrill Lynch on the Spot. New York Times. pp. C1-C2. Read More