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Generational Dynamics Web Log for 25-Oct-07
What did Merrill know, and when did they know it?

Web Log - October, 2007

What did Merrill know, and when did they know it?

Merrill Lynch writes down $8.4 billion in bad security holdings, just two weeks after they had said that the writedown would be only $4.5 billion.

Starting with the Bear Stearns debacle that became public in June, there have been one story after another with the same theme: Banks and other financial institutions are taking every possible step to hide from the public the losses from bad securities (usually mortgage-backed CDOs and other credit derivatives) in their portfolios.

The investment community was shocked on Wednesday to learn that Merrill will take $8.4 billion in write downs for bad securities. That includes CDOs that had a high notional value, but had to be marked down in value by $7.9 billion.

The problem is that it was just two weeks ago that Merrill said that the writedown would be only $4.5 billion.

How could they have made that mistake? I mean, it's one thing if you can't balance your checkbook because you've lost track of a $3.25 payment somewhere, but no one should ever lose track of four billion dollars, especially one of biggest investment banks in the world. A billion here and a billion there, as the saying goes, and pretty soon it adds up to real money.

Merrill is making excuses, of course. "Well, gawrsh, we figured it all out and came to a figure of $4.5 billion two weeks ago. But we did some 'additional analysis' over the last two weeks, and now it's $8.4 billion."

Is Merrill willing to guarantee that there won't be any more writedowns? No, they aren't, although they have "only" $15.3 billion in CDOs left.

And there's the problem. If Merrill made this mistake, aren't other banks likely to be making similar mistakes?

And banks are the experts. If they're making such huge mistakes, what about financial organizations of lesser expertise -- mutual funds, investment trusts, hedge funds, savings banks, pension funds, college endowments, money market funds, insurance companies?

The thing is, as I've said before, what's going on is fraud. People have invested money in funds that may be backed by mortgage-based securities that are worth a lot less than the fund managers claim. That means that the investors stand to lose a great deal of money.

As cynical as I am about what's been going on, I'm still really shocked by how bad it's gotten.

It's incredible to me that you have Treasury Secretary Henry Paulson cooperating with Citibank to set up this M-LEC or "Super-SIV" whose purpose is specifically to allow financial institutions to sell worthless securities to one another at inflated prices, in order to establish the inflated price as a "market value."

For those of you readers who are students of the Bible, I'm sure that you must recognize the kind of debauched, depraved behavior that we're seeing today, although admittedly there were no collateralized debt obligations (CDOs) that we know of in Sodom and Gomorrah.

But it's interesting from a generational point of view, how the "last days" of any society or nation, prior to the start of a new genocidal crisis war, always feature a complete unraveling of all the rules that the society adopted at the end of the preceding crisis war to guarantee that no such war would ever happen again. I know that my 1950s schoolteachers, who often talked about the greed that led to 1929, would be in a state of shocked disbelief at the depraved financial behavior that's the norm today.

I've been predicting since 2002 that we would have a generational panic and stock market crash and a new 1930s style Great Depression, so I'm not surprised that each day we're obviously closer to that result.

But what's really shocking to me is the public displays of depravity and dishonesty. A few years ago I never would have believed that this was possible, and even a few months ago I could not have believed that this behavior could get so bad, and keep getting worse.

The intent of all this depravity is to prevent banks and other financial institutions from having to mark their securities to market, which would mean huge writedowns, such as those from Merrill Lynch.

But those writedowns are happening anyway. The SIVs and the Super-SIVs and the M-LECs can't keep worthless securities at artificially high prices forever. As one institution after another is forced to revalue their assets, pretty soon there may be a domino effect.

As I've said many times, Generational Dynamics tells you what your final destination is, but it doesn't predict how you'll get there. I've been speculating that the worldwide financial crisis could be triggered by a panic on Wall Street or in Shanghai or Hong Kong.

But maybe it will be something quite different: The panicked selling of mutual funds, hedge funds, and other portfolios containing CDOs, before the CDOs have to be marked to market.

At any rate, bubbly investors now have one less hook on which to hang their hats.

In the "bad news is good news" frame of mind, investors have been treating previous writedowns as a good thing. The phrase we've been hearing was that the third quarter was a "kitchen sink" quarter, meaning that financial institutions would get all their writedowns out of the way in the third quarter, so that they could go back to inflating the bubble in the fourth quarter.

This concept is no longer viable. It's now clear that, at best, financial institutions have no idea how big their exposure is and, at worst, they do know, but are fraudulently hiding it from the public.

Either way, bubbly investors are now beginning to realize that the "kitchen sink" concept doesn't work, and that there will be a lot more writedowns in the quarters to come.

And with foreclosures surging and real estate prices falling, it's increasingly clear that much worse is yet to come. (25-Oct-07) Permanent Link
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Generational Dynamics Web Log for 25-Oct-07 What did Merrill know, and when did they know it?

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Generational Dynamics Web Log for 25-Oct-07
What did Merrill know, and when did they know it?