Merrill vs Bear: Two Contestants, No Winners

You may have overlooked this short but fascinating column in Bloomberg yesterday:

"Merrill Lynch, founded in 1914, sold hundreds of millions of dollars worth of collateralized debt obligations to hedge funds run by Bear Stearns, started in 1923.

Some 90 percent of the face value of the CDOs was loaned to Bear by Merrill, as is normal in such transactions. When the prices of the funds’ CDO holdings started to fall in June, Merrill demanded that the firm increase collateral in what’s known in the debt markets as a margin call.

Bear Stearns executives pleaded for time, arguing that the forced sale of their assets would push down all CDO prices. Merrill Lynch officials brushed off the entreaty, according to people involved in the discussions.

In June, the hedge funds, run by Ralph Cioffi, sold $3.8 billion of CDOs to meet margin calls by Merrill and other lenders that were following its lead. The fire sale led to a further drop in CDO prices."

Now, that’s a pretty straight forward tale of a creditor pressing a debtor for additional (contractually required) collateral. The sale actually caused a "Mark-to-market" event that forced actual (versus modeled) pricing to occur.

But what makes this tale so unusual is the sprawling nature of the big Wall Street supermarkets investment banks: It turns out that of the many companies affected by this market pricing, one of them turns out to be Merrill:

"Among those that lost value: $23 billion of CDOs Merrill held on its own books. In October, Merrill wrote down the value of all of its mortgage-backed holdings, including CDOs, by $7.9 billion and declared a loss for the third quarter."


But it was inevitable: The more diversified each firm becomes as they expand, the more the entire financial ecosystem looks like one giant iBank.

Expect to see more of this sort of thing in the future . . .


In Unforgiven Margin Call, Bear Funds Failed on Merrill CDOs 
Yalman Onaran
Bloomberg, Jan. 3 2008

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What's been said:

Discussions found on the web:
  1. Eric Davis commented on Jan 4

    Luckily, when the “hamburgler” was on yesterday, I caught that when I was on bloomberg.

  2. Michael C. commented on Jan 4

    Nice surprise to hear you on XM Radio (I was listening to Ch130 – Potus 08), Barry!

  3. michael schumacher commented on Jan 4

    The last line should say

    “expect to see more of these one time charges”

    How Jimmy Cayne still has a job shows you how entrenched his BOD is with his own people.

    People have been killed for less of a loss.


  4. halbhh commented on Jan 4

    Interesting post Barry.

  5. Mike G. commented on Jan 4

    I saw the one-liner go by in the crawler during Pimm Fox’s show and wondered what that was all about, but I forgot to look online later!

    Speaking of Bloomberg (and Fox’s show in particular). Why do they have such poor time management? Most of the time a guest will be talking on a show and the music will start playing and everyone gets the hint that it’s time to make the point and put a button on it before the break. Not on Fox’s show! He’ll ask a guy a question, you’ll get 20 seconds into a response and hear “Uh! Sorry Barry! I’m going to have to stop you right there but we’ll let you finish your point after the break.” It looks like community tv or something.

  6. Ross commented on Jan 4

    Spam filters 2. Lil ole me 0.

  7. cinefoz commented on Jan 4

    The next big crash will come as a result of Chinese stock market bustup. Hong Kong will drop in sympathy. The rest of the world’s markets will also dip out of fear.

    Any guesses when? This will be a great buying opportunity for hose with cash on hand when it happens.

  8. cinefoz commented on Jan 4

    PS. Sorry for the typing errors above. No, I don’t write assembly instructions for Chinese imports.

  9. Steve Barry commented on Jan 4

    No we know why this is happening in such slow motion…by calling forcing Bear to take the mark, Merrill would hurt its own situation. of course they waited until an absolute blowup occurred. Same thing happening throughout the financial credit bubble, er system.

  10. Steve Barry commented on Jan 4

    CNBC update just said president met with his working group on markets today…better known as the PPT. Hmmmmm.

  11. Eric Davis commented on Jan 5


    Optimistic me(the opposite of paranoid me), likes the idea that the meeting was called by the smirking chimp, because he didn’t understand why Interest Rates weren’t 1%.

    And they took a few hours to explain the basics of inflation, Dollar policy and global economics to the Harvard MBA.

    Either that or they were planning out the 2-3 unscheduled “Announcements” we will get over the next few weeks…

    Oh, that is my favorite conspiracy theory… I may have to start a web site.

    I’m dying to know when the GAO will start figuring out how/why someone is losing so much money buying market futures.
    I hope they aren’t planning to ride those out till 2012.

    Paulsen: “Mr. President, I got a call from the SEC. They had some questions about the “special” trading account. Could you give the a call, or maybe sick Cheney on them.”

    I joke, and am still a bit suspect on this one…. but the futures action is a little suspect…

  12. Winston Munn commented on Jan 5

    I’ve mentioned this before but it has received little-to-no “air” time, but as pay-option ARMS begin to reset in 2008, there is sure to be controversy.

    The undiscussed item is CINA, AKA capitalization of income from negative amortization. Under current accounting rules, the unpaid portion of pay-option ARMs is counted as current income.

    This would be like me loaning out $100 to my deadbeat uncle, Crazy Uncle Billy, and when Crazy Uncle Billy comes to pay me he says he can only afford to pay $10, so I accept the $10 minimum payment but at the same time count the $90 of unpaid, rolled over debt as current income.

    This doesn’t sound on its surface a huge problem until you see how CINA has contributed to some banks’ earnings.

    For example, Wamu in Q1 2007 reported net earnings of $784 with $360 of that contributed by CINA – 45.9% of the net earnings.

    It makes me wonder how many earnings restatements from the banks will be forthcoming over the next 2 years, and it certainly makes me wonder about the validity of the P/E ratios.

    In this subprime-mortgage-debt bubble unwind, it appears there are so many shoes yet to drop one would think the entire thing had occured in the closet of Imelda Marcos.

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