Counting the Cockroaches at Merrill Lynch

I believe that Merrill Lynch, and probably some of the other big financial institutions, don't fully understand the extent of their losses in Structured Investment Vehicles (SIV). I previously commented that the fact that Merrill Lynch increased their write-off from $5B to $8.4B in a week shows that they are guessing - marketing to model. It reminds me of the old adage that if you see one cockroach there are many, many more that you don't see.

The real danger to the shareholders is that there is no way of knowing how deep Merrill Lynch is into this mess. Much of their SIV holdings are hidden in off-balance sheet accounts - some that have been moved off shore for further secrecy. No ones knows how many billions of dollars in SIV's are held by Merrill Lynch and what mix of mortgage securities are backing these SIV's.

The tipping point appears to have been last summer, when 3 senior executives were fired by Merrill Lynch. It was reported by CNBC today that at this point Merrill Lynch's mortgage backed securities portfolio stood at about $2B. Subsequently the firm expanded its SIV exposure dramatically, from as low as $20B to what some have speculated was as high as $40B.

Merrill Lynch fired its CEO today. Maybe "fired" is a bit strong a word, since Stanley O'Neil received $161M in compensation for leaving. Clearly Mr. O'Neil did a terrible job in allocating capital and managing risk. But at this point the Board of Directors has a fiduciary responsibility to the shareholders to shine a bright light in the dark room of off-balance sheet shenanigans.

Mr. O'Neil should receive credit for the fact that he was instrumental in turning Merrill Lynch around after it fell into hard times a few years ago. Nevertheless it is his responsibility that Merrill Lynch took the leading role on Wall Street in dealing these CDO's.

I thought the whole point of the post-Enron reforms was to make sure that opaque off-balance sheet debts would not be allowed. The SEC is absent as usual. The government's proposal to create the enormous pool of shared securities will only keep these SIV's off the books of the big firms, and that is wrong.

Wall Street is stumbling around with no idea about how to price this stuff. I predict we will see further write downs for the next several quarters as a result of this mess.