Merrill Lynch Bull

Merrill Lynch Bull

So, a week after announcing posting a 4.9 billion loss, Merrill announces another 5.7 billion write-down. And says it’ll be trying to raise 8.5 billion with a stock offering (and how low will they have to go, and how much will they have to dilute ownership to raise that much money?)

But the key graph in this Reuters story isn’t the headline multi-billion dollar numbers, it’s a little thing known as a market price:

In a sign of how toxic Merrill’s debt holdings have become, it has agreed to sell $30.6 billion of collateralized debt obligations (CDOs), a kind of repackaged debt, to an affiliate of private equity fund Lone Star Funds, for just $6.7 billion, or about 22 cents on the dollar.

See, a lot of CDOs and other collateralized securities trade very thinly. There often isn’t an actual market price for what they’re worth. So instead of valuing based on what someone would pay for them today (as opposed to, oh, 2 years ago before the meltdown) they are valued based on "mark to model", more aptly described as "mark to make-believe".

But when you have actual market prices, you’re supposed to use them. I wonder how many companies holding toxic waste CDOs are going to be having screaming arguments with their accountants over the next couple weeks, when the accountants say "well, we have a price, we should mark to market now". I know in their shoes I’d be awfully tempted to argue that the valuations are too specific to be generalized out very far, because if they are taken as real market prices, well, a lot more companies are going to be taking huge writedowns, having to raise capital, and if they can’t, going belly up like a dead flounder. Or, since Merrill actually loaned 75% of the purchase price (say what, will no one pay anything for this junk?) perhaps they’ll decide that when you’re loaning the money to someone to take them off you, it doesn’t really count.

I will also note, for the record, that the Fed’s term facility is taking exactly this sort of trash at near face value in exchange for loans. I and others have long argued that they were at great risk of winding up holding a bunch of toxic waste worth only cents on the dollar, and that what they were doing was a huge government bailout. We now have an idea of just how much the government is on the hook for. All the debt may not be this bad, but then, wouldn’t you give the Fed the worst stuff as collateral and try and hawk the better stuff? So the US taxpayer may indeed be looking at losing more than 78 cents on the dollar.

Finally, of course, Merrill had been saying that it had previously raised more capital than it needed, and had conservative valuation. Turns out they were, what’s the word? Oh yeah, lying. No surprise, and they won’t be the last one. But what it means is that investors, not knowing who to believe, are going to keep getting even easier to spook and stampede.

Merrill’s remaining debt is mostly from 2005 and before, which is supposed to be more solid (read: fewer liar loans and less BS underwriting) but the problem is that the housing market is likely to drop far below 2005 prices before this is all over.

Merrill isn’t out of the woods with this, and neither is anyone else. But we’re beginning to get a feeling for just how far into the howling wilderness we are, and that 22% percent figure will have a lot of finance executives listening for the sound of howling tribes of burned investors and fleeced taxpayers.

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