Merrill Marks CDOs to Market, Other Banks Cringe

During Merrill Lynch's earnings report on July 18th, CEO John Thain claimed that buyers were offering prices for the $19.9 billion in CDOs remaining in its inventory that were too low to justify a sale.  At the time, I argued that he was admitting that the assets were marked too high on Merrill's balance sheet and that it would required further write-downs.  I didn't realize it would happen within two weeks.  I find it extremely disturbing that the report of Merrill's CDO sale and new capital infusion came so close to the second quarter earnings report.  Frankly, it implies that the company's earnings report was a sham.  Nothing happened in the past two weeks that caused CDO prices to fall.  Merrill consciously chose not to mark the securities to market, arguing that the market was wrong and that its models were right.  It seems very hard to believe that the deal to sell the $11 billion in CDOs to a Lone Star affiliate, while providing the financing, was scraped together in two weeks.  It had to have been in the works and it implies that Merrill deliberately marked the CDOs at a higher price than where they were ultimately sold.  Had Merrill marked the CDOs to the price where it sold those assets a mere two weeks later, it would have reported a net loss of $10 billion rather than $4.65 billion.  That number may have proven too high for investors to stomach and would have spoiled the plans for the equity issuance.  Perhaps Merrill had to wait for the SEC to put a clamp on short selling first before announcing the deal?  Maybe Merrill thought it would sound better splitting the loss into two chunks?  I'm just making educated conspiracy theory guesses but something smells very fishy here.

Furthermore, now that Merrill has traded these assets at a price, and that price is roughly 20 cents on the dollar for "super seniors", they have marked the entire market.  Anyone holding CDOs of any variety will need to reference this trade when marking their assets until someone comes along and trades them at a different price.  Before yesterday, there was no price because there was no market.  Dealers could claim they were doing their best to supply a price.  I smell a slew of write-downs to come.  But no worries, only 20 cents to go before they go to zero, and then, we can safely say that the worst is over.