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Stan O’Neal, Merrill Lynch’s chairman and chief executive |
The O’Neal era Merrill ethic
As well as discussing the risks in the market, he outlined why the long-term prospects for investment banking are bright: how global capital flows are opening new markets and providing a new resilience to financial markets; and how the role of an investment bank as an intermediator of capital will grow in both developed and developing markets.
Everybody seems to be expecting a downturn in financial markets. When will it come?
Let’s start with the positives, because out of the positives come some of the concerns for risk. There’s growth in virtually every part of the world simultaneously, and reasonably healthy growth. Wealth is being created in the process, so there’s also lots of liquidity. At the same time markets have become much more interconnected, and there’s a freer flow of capital. Increasingly sophisticated investors are directing more and more of the flows. The upshot is that there are a lot of opportunities across asset classes that did not exist perhaps just a few years ago.
The corollary is that some liquidity finds its way into asset classes in outsize proportion, so you can get distortions in those asset classes. We see that in credit-related products, and we’re seeing it in the US housing market in particular, but also in leverage finance and high-yield corporate issues.
These excesses, and imbalances that exist in areas such as the US current account deficit and how that is being funded, give some pause to what scenarios might look like under negative circumstances.
How bad could the sub-prime correction become in isolation, and what are the risks that it will spread to other markets?
[As of late June 2007] it is reasonably well contained, and there are no clear signs that it is spilling over to other subsets of the credit markets. The most pronounced troubles that we’ve seen so far are the typical combination of not only credit and complex structures but also insufficient liquidity in vehicles that had to maintain a certain amount of liquidity in order to continue trading in the face of losses or changes in the market dynamic.
One sign of an impending downturn is that banks stop hiring. But you and your competitors continue to build your teams in credit markets.
We’re still in a cyclical business, and unfortunately there’s no way we can change that. But investing purely on a cyclical basis is a mistake. We try to look to longer-term fundamental trends such as those I mentioned before.
In addition, the role of capital markets as an intermediator of capital continues to grow, notably in such places as Japan and Europe. As an investment bank this is our area of expertise and it gives us opportunities, beyond GDP growth, beyond the growth of wealth, as an intermediator of capital, and in some cases as a principal investor in those opportunities as well.
These opportunities will not develop without disruption, volatility and risk, of course, but in the longer term they will drive our business and growth, particularly outside the US, where our business has been growing at multiples of what we see in the US.
Do you think markets are more resilient these days? They seem to have coped well with recent shocks such as GM and Amaranth.
I think so, albeit there are still systemic risks in the marketplace. One reason is that many more investors have mandates that don’t require them to be narrow investors in one part of the market, or to be long only, which tends to exacerbate whatever moves take place in the marketplace.
When money is managed with more flexibility around different mandates that have options to take views in many different ways, it provides a certain amount of resilience to the market and a certain amount of lubricant when there are significant dislocations in terms of value. And credit derivatives add to that resilience.
We saw that in the credit disruption in autos a couple of years ago, and we certainly saw that in Amaranth.
So globalization actually means that not all markets go up and down together?
The freer flow of capital is a definite positive but it is not a total solution to contagion.
Everyone wants to know what would trigger contagion. And in all my discussions with regulators and with peers who manage businesses like ours, everyone comes to the same conclusion: no one has ever been able to predict the event that would cause a contagion.
But you can be sure there is a risk of one, and I think the most important thing is to prudently manage liquidity, because it is the only sure-fire way of withstanding significant disruption in the marketplace.
The key talking point in investment banking at the moment is how to strike a balance between client needs and those of shareholders – the agency versus principal debate. Where does Merrill Lynch stand?
In today’s world it is difficult to separate the idea of using your own capital and servicing clients. Of course there are conflicts from time to time; there is no inherent conflict in the strategy. In fact it is important to be able to put capital to work in order to serve clients well: helping them to manage risk, sometimes offload it, sometimes reconfigure it in ways that allows it to be redistributed or managed more efficiently.