Merrill may have also become addicted to the enormous fees it collected from underwriting collateralized debt obligations (CDOs), which reached nearly $1 billion in 2006 and 2007 combined. Because CDO investors demanded the lower-credit, higher-yielding slices of the securities, Merrill did not have enough of a market for the investment-grade tranches and began keeping them on its books. Its pre-crisis holdings peaked at an only partly hedged $41 billion. As with Morgan Stanley, Merrill apparently felt those tranches were reasonably safe. And that may have made Merrill reluctant to pay the high cost of such insurance, says Tanya Azarchs, banking analyst at Standard & Poor's. "But by the time people realized what was happening, it was too late to do anything," she says.

In December, Merrill appointed former Goldman president and NYSE head John Thain as CEO. He has since hired CFO Nelson Chai, also a former NYSE executive, and integrated market and credit risk under two co-CROs — former Goldman global risk officer Noel B. Donohoe and Edmond N. Moriarty, formerly Merrill's chief credit officer. Both report to Thain. In addition, Thain has instituted weekly risk meetings and changed the compensation structure from one that encouraged risky bets to one that reflects "firm results first," according to a January presentation.

Big Isn't Always Better
For Citigroup, the subprime crisis simply accelerated a downward slide. With investors calling for the bank's breakup long before the crisis, Citigroup's $20 billion subprime-related losses and its battered structured investment vehicles (SIVs) further exposed the difficulties of managing this complex institution. In fact, in addition to taking onto its balance sheet as much as $43 billion in CDOs, Citi had close to $100 billion in SIVs.

Internally, the finance function has been in flux for some time. Two consecutive CFOs — Todd Thomson and Sallie Krawcheck — were replaced in short order. It wasn't until last March that the bank hired what one corporate-governance scholar calls a "professional CFO," American Express's Gary Crittenden, but by then it was too late. Indeed, in an analyst call in October, Crittenden conceded that Citigroup's massive CDO losses had to do with failure to properly monitor the value of the bank's CDO holdings until it was too late to hedge or sell them. Collaboration "between the credit-risk team and the market-risk team was not as strong as it needed to be," he said. "We have to have more integration between the way those teams operate."

Like Merrill's, Citi's CDO losses were disclosed gradually. (Ironically, Thomson had been in charge of risk as CFO, but that structure was dismantled during Citi's struggles to overcome a series of crises over reputation risk.) A $5.9 billion third-quarter hit predicted in November mushroomed to $11 billion in December. CEO Charles Prince, who in the summer said that Citi would "keep dancing" as long as the music played, resigned. The bank named Pandit as CEO in December and split the role of CEO and chairman. But those and other corrective steps did not prevent a fall in the bank's capital ratio to 7.3 percent from its 7.5 percent target, triggering a downgrade from Moody's Investors Service.

Overall, the risk function at Citi lacked visibility or direct lines to the top. Former CRO David Bushnell reported to Citi vice chairman Lewis Kaden, who had been a chief administrative officer, an ineffective organizational structure, according to corporate-governance gurus. Just prior to his retirement in November, Bushnell served as both risk officer and chief administrative officer, reporting to Prince. In November, the bank named Citigroup risk veteran Jorge A. Bermudez as CRO, reporting directly to acting CEO Sir Win Bischoff. Citi also formed an advisory committee of senior leaders from across the company that will provide input on ways to strengthen risk-management processes. The group meets weekly, with the CEO often present.

Crittenden, meanwhile, has said he would centralize the treasury functions to "facilitate the allocation of capital to our highest growth and return opportunities." He is also in charge of conducting an ongoing review of the bank to increase efficiencies, including head count. A second, one-time review of all the bank's businesses is under way and is headed by Pandit. That review will yield results that may include a breakup — a scenario under which Crittenden might be tapped to head a division.

What's Luck Got to Do with It?
Still, not every bank CFO considers 2007 a disastrous year. JP Morgan Chase, Credit Suisse, and Deutsche Bank all emerged relatively unscathed from the crisis. Lehman Brothers, a big player in mortgages, with an estimated inventory of $80 billion in mortgage-related securities, also avoided major pain, returning 16.6 percent on capital in 2007 — largely thanks to revamping its risk-management system after the 1998 Asian crisis.

It was Goldman, however, that got Wall Street's attention. In December 2006, the bank's controller group alerted CFO David Viniar to mortgage-related losses that had occurred for 10 days on the firm's P&L. (Goldman has not disclosed the exact amount, but says it was "in the millions.") In response, Viniar called a meeting that included the controller division, the mortgage traders, and the senior risk managers. Discussions revolved around the firm's long subprime holdings and ended with the conclusion that "we'd rather be short than long," says a person close to Goldman.

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