What It Takes: Lessons in the Pursuit of Excellence

by Stephen A. Schwarzman

In early 2008, I had dinner with John Mack, the CEO of Morgan Stanley. He was miserable, having just reported a quarterly loss of $7 billion. How had he managed to lose so much money? He hadn’t, he said. It was all on paper. He had portfolios of subprime securities dating back four years. The underlying mortgages on the securities for 2004 were defaulting at a rate of around 4 percent, for 2005–2006 at 6 percent, and for 2007 around 8 percent. But the market for these securities, even with default rates below 10 percent, had evaporated. No one would buy them. Fewer than one in ten Americans were defaulting on the mortgages backing these securities, yet they were considered untouchable. Under Sarbanes-Oxley, the financial reform act introduced in 2002 to protect investors after the accounting scandals at Enron and WorldCom, you couldn’t take the risk of misrepresenting the value of any assets. So John had brought in BlackRock to value its portfolio. They estimated the loss to be somewhere between $5 and $9 billion. He simply split the difference, reporting a vastly larger loss than the value of the securities that were actually defaulting. And suddenly everyone was panicking about the health of Morgan Stanley.

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