Were O’Neal and Prince undone by the butterfly effect?

by Patrice Sarath, November 6th, 2007, 7:00 am

Stan O’Neal’s departure from Merrill Lynch had an air of efficiency about it. When the last straw broke the camel’s back — his lone wolf conversation with Wachovia regarding a possible merger — he was gone, baby gone.

Charles Prince’s exit from Citigroup had the same inevitability about it, although Prince never had a grace period at all during his tenure. The banking behemoth had struggled under his years of leadership, and never soared, as befitting the bank that was once the largest in the world.

Surely there is despondency on Wall Street these days, that and fear — who’s next, bankers must be asking. Bear Stearns‘ James Cayne had the dubious honor of being profiled unflatteringly by the Wall Street Journal, but there’s no indication that he’s on his way out. That could be because Bear Stearns has already sacrificed its lamb; Warren Spector was sent packing after two Bear hedge funds failed so spectacularly.

This reminds me of the so-called butterfly effect. Not the dismal movie of the same name, but a rather interesting take on the classic trope — a butterfly flaps its wings in Asia, causing a sequence of events that results in a hurricane brewing in the Atlantic. In this case, I imagine the butterfly to be one of those telemarketing mortgage brokers in a boiler room somewhere in California. He sells the subprime ARM that gets bundled into a bunch of CDOs that investment banks, hedge funds, and financial services companies all over the world invested in, all shiny with its high rate of return, and it’s an investment that can’t fail, right, because these are all masters of the universe.

Except that the masters forgot a very important thing. Two important things, actually: One, that the butterfly effect is another name for chaos theory, and you can’t control chaos. And two, that ARM? It was a loan to a real person, who never should have qualified for the loan in the first place. When the mortgage broker made the loan it was a good investment, but as soon as the homeowner defaulted, it was a chill wind that blew from that butterfly’s wings, first a puff of air, then a breeze, and finally a gale.

One thing is for sure — Prince and O’Neal will have plenty of time to catch up on their reading. I suggest Ray Bradbury’s A Sound of Thunder.