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Merrill's mess

Robert Peston | 09:19 UK time, Monday, 29 October 2007

All weekend, wave after wave of schadenfreude has been crashing on the head of Stan O’Neal, the chairman of Merrill Lynch. After Merrill announced those colossal losses on inventories of sub-prime loans reprocessed into noxious collateralised debt obligations, O’Neal could not survive.

Stan O'NealThe point is that Merrill’s historic strengths have been as an agent, a broker, not a risk-taker. So its veterans launched into the “I-told-you-so” dance when “new Merrill” came a cropper from putting its capital at risk in the manufacture of securities out of loans to US homeowners with poor credit histories.

But it’s the ghost of Christmas yet-to-come that really did for O’Neal. I can be confident of that from the tedious moaning of old mates who work at Merrill. They’re whinging that they are being short-changed on this year’s bonuses because of the humungous losses chalked up on sub-prime. If they’re making a sacrifice for the good of the firm, someone has to pay.

The real power in any investment bank rests with its fee-generators and top traders, rather than with its shareholders or even its board, because it’s curtains for the firm if they’re alienated.

Merrill’s board, in negotiating O’Neal’s departure, has simply been trying to preserve the integrity of a giant, money-making collective.

For the rest of us, the Merrill mess is an occasion to breathe a sigh of relief about what might have been – and cross our fingers about what might yet be to come.

Just imagine the carnage if the credit losses of a Merrill Lynch had been married to the intrinsic funding weakness of a Northern Rock.

A great deal has been made – rightly – about the flaws in the global financial system, in which trillions of dollars of loans have been packaged up into a dizzying number and variety of securities that have then been sold and then resold. What we learned from the panic that ensued in markets this summer is the potential harm that flows when major financial institutions have no idea what has happened to the risks associated with all that lending.

But the differing debacles at Merrill Lynch and Northern Rock point to at least one saving grace, which is that the worst loan losses have not occurred in a major institution with inadequate access to liquid funds,

However that may be due to luck more than anything else. And we cannot assume it won’t run out.

As the Bank of England implied last week, we may be about to enter a second horrible phase of the credit crunch. A general tightening of credit conditions could cause serious difficulties for weaker borrowers, if they’re unable to refinance their debts, and also wider discomfort if there is a slowdown in economic growth.

Which is why all the bankers I meet are still battening down the hatches and are desperately trying to ensure they have access to sufficient cash or liquidity to weather any storm.

Comments   Post your comment

  • 1.
  • At 11:32 AM on 29 Oct 2007,
  • Peter Dragomer wrote:

Amazing ! as an ex ML employee I would never have thought any serious financial institution could get themselves into this kind of a mess, as ML has some the top analysts and brains in the industry...well, they deserve it if the idea was to push these repackaged loans as securities. I can only say that apart from Stan, the Global Head of Sales and cronies also need to be pushed out. Whoever signed off the credit risk on these instruments definately needs head chopping as well. In a sad kind of way, am glad I got out when I did, and hopefully this backfire explosion in the face of those responsible for the debacle will have taught the new Institutional Sales force generation not to have as a mantra "greed is good"...otherwise they are deluded.

  • 2.
  • At 11:46 AM on 29 Oct 2007,
  • robert marshall wrote:

Perhaps the irony of Stan O'Neals departure is that Merril appears to have truly cleared the decks on damage incurred.
What is still of major concern is that no consequential market pricing has been set for trillions of dollars of sub prime loans outstanding.
So all outstanding write downs declared to date must be seen as contentious.
Until that is done, liquidity will not be there and conditions will keep tightening.
To top it all off the Chamcellor's comments on 'off balance sheet' finances by the banks shows an amazing disregard for the outrageous PPI debt this government has generated that will saddle generations to come.
Were that to go on the books which any right minded individual would be obliged to do if they were truy 'prudent', we would really be up the proverbial creek!.
Adopting the action of silence and minimal comment will not secure the end game for us.
In the final analysis it is all about greed and honesty.
What we need to ask oursleves is does our present regulatory system have it right?
If it does not then we can't adopt years of debate as to the solution.
We all know the weaknesses in the system now and the sooner they are eradicated the better. For sure if it puts the banks noses out of joint then so be it!.
Let us not forget the profits they have amassed over the last 10 years, it is the only way to put the real damage into context.
Yes we need strong banks but not built on superficial balance sheets because all the mess is off it hidden.
Industry across the board and the public must not be left to bail out banks for irresponsuble speculative decisions.
No bonuses should be paid to anyone until we can all see the real damage.
Merill clearly can not be the only company clearing its decks, the more banks who do the same the greater will be the impression that they are living in the real world and faster confidence will return.
Further the clear out should not benefit those leaving by one penny or cent. They have made more than enough to date and must leave in disgrace.
Save a world war the knock on effect of this Sub prime loan fiasco is the mother of all crises and no soft measures can be adopted.
Industry and the Public has a right to see the clear out that is required given it will be saddled regardless for years sorting teh mess out!!

  • 3.
  • At 11:46 AM on 29 Oct 2007,
  • michael hogan wrote:

John Kay says it all in his book The truth about markets. He says that Piper Alpha losses nearly killed the Lloyds market, just as Long Term Capital Management nearly did for New York, because those who were trading risk did not expect it to come hurtling back to them like a boomerang. Merrill made the same mistake with subprime and credit derivatives. That is awfully bad risk management.

  • 4.
  • At 11:49 AM on 29 Oct 2007,
  • ian wrote:

This could be the tip of the ice cube... and how long will it take to see how many other giants have losses to share with the financial comunity!

  • 5.
  • At 12:02 PM on 29 Oct 2007,
  • TRUST_NO_1 wrote:

The derivatives markets,which is an unknown regarding which financial institutions hold the liability , runs into trillions of $'s or £'s,has the potential to completely wipe out any of the world's major banks.
When it starts to unwind,panic will ensue.The sub-prime mortgage debacle is small fry by comparison.
Banks create money out of thin air.
What value would you put on a piece of paper if I produced them on my printer at home ?
Well that is what banks around the world do .They don't even have to print it these days,as it is created electronically.They have no collateral behind it.They used to back it with gold,but not anymore.

I have no money in the bank,but I do own gold and silver mining stocks.
Don't be too late joining in the gold and silver market as their prices will explode once derivatives implode.

  • 6.
  • At 12:36 PM on 29 Oct 2007,
  • sam wrote:

In my view, this was a Mark To Market loss. So Merril may not actually incurr any loss going forward when the market condition improves and the stocks are back up again (potentially after a fed rate cut on wendesday).

  • 7.
  • At 01:10 PM on 29 Oct 2007,
  • Nigel Wilson wrote:

The first stage of the credit-crunch has been the realisation that there are noxious funds out there. This has brought some shocks to the markets but, surprisingly, these continue to be absorbed for the time being.

As you rightly point out we are faced with a large financial black hole that could, given poor management, swallow the economy as we know it.

Since that management has also been up to its armpits in creative accounting, I am fearful we are all in for a rough time.

For the sake of our own future integrity the final stage of the credit-crunch must be when we hold all the agents of this chaos to account and force them to pay in full.

  • 8.
  • At 01:12 PM on 29 Oct 2007,
  • Colin Smith wrote:

For a bunch of people who literally have a license to create money from nothing, they're remarkably bad at managing it. Amazing.

Credit Crunch = Recession.

Time to switch to cash... Unless of course the central banks panic and drop the interest rates a bizarre amount.

Full Reserve Banking I say. Enough of the booms and busts. Enough of the inflationary theft.

  • 9.
  • At 01:15 PM on 29 Oct 2007,
  • warren wrote:

I think that you'll find that Merill is funded in almost exactly the same way as Northern Rock.

  • 10.
  • At 01:21 PM on 29 Oct 2007,
  • ian wrote:

interesting and what's more is that the buy to let market in the US has also been funded by sub prime, and the renting community in those houses are also being evicted... How long will it take for this to reach UK shores?

  • 11.
  • At 01:56 PM on 29 Oct 2007,
  • PhilipM wrote:

Michael Hogan (post 3 above) is right - this is very poor risk management. Worryingly, the lapses seemingly occured within ML's most senior management. When sub-prime loans became available to securitise and repackage with presumably higher than average reward, what happened with the old principle of "if it looks too good to be true, it probably is"?
It only requires a few good common sense questions to be asked for the dangers of this sort of activity to be exposed - and a company can then position itself accordingly. But in the absence of such common sense, the only real conclusion that you can arrive at is that greed is ruling management's judgement.
Not satisfied with remuneration packages of eye-watering proportion, it seems that those concerned were intent on sucking even more from the business - with scant regard for the consequences.
Stan O'Neal should do the right thing and fall on his sword and take the others responsible with him. When you lose a business literally billions of dollars, you forfiet your right to try to fix it.

  • 12.
  • At 02:28 PM on 29 Oct 2007,
  • JE-NYC wrote:

It is incredible that Mr Peston cannot for one second refrain from taking yet another swipe at Northern Rock, have you no shame sir? The model was fine, no one would expect such a change in the markets, the bank was solvent and used the BofE exactly what it was for. If it wasnt't for your scaremongering on the BBC the pensioners wouldnt have lined up for their cash. Your "inside information" was also dubious, how you knew of a dividend change before the exchange is a question which should be raised, are you working for one of the PE firms or Virgin Money?

  • 13.
  • At 06:39 PM on 29 Oct 2007,
  • deaglecat wrote:

Surely there are some pretty simple sums which can be used to calculate when the sub-prime problem has been accounted for.

How much has been loaned ?
What is the current default rate ?
What is the predicted default rate (probably interest rate dependent).

Then once the aggregated individual institution/fund write-offs exceed the amount of the bad debt, we can consider the sub-prime problem to be over. Clearly, we are not there yet.

I understand the issue with hedge funds which do not need to declare their losses - but surely a ballpark estimate can be made...


  • 14.
  • At 07:21 PM on 29 Oct 2007,
  • Tony wrote:

Sam says Mark to Market is to blame and the losses will disappear when the market recovers. That's the refrain of Nick Leeson and all other bust traders and bankrupts - "If only the Bank had supported me a bit longer...." - The sub-prime losses are based on mortgage cashflows and the value of houses held as security which are not going to come back quickly, if at all.

  • 15.
  • At 08:01 PM on 29 Oct 2007,
  • Melody wrote:

Ok, so the question I have is doesn't Merrill have a Chief Risk Officer and if not, why not?

If they do have one, I imagine his head would have to be on the block too.

Another example that heading up a wall street firm is a high stakes game.

  • 16.
  • At 10:06 PM on 29 Oct 2007,
  • Niels wrote:

In that now-famous underground car park in Rosslyn, Deep Throat once reportedly said of the doomed Nixon administration to The Washington Post's Bob Woodward that they were a 'bunch of not very bright guys and things got out of hand'. All these years later I get the same uneasy feeling about the litany of massive write-downs being announced by major US investment banks.
Things have clearly gotten out of hand, but is it really conceivable that there are whole bunches of not very bright guys and gals running these world-leading concerns?
Niels, Denmark

Feeling utterly nervous, I thought credit cruch toll may limity to Royal Bank of Scotland and Lloyds TSB but here it seems highly trsutworthy bank like Merrill Lynch has black hole as well:(

  • 18.
  • At 06:18 AM on 30 Oct 2007,
  • K Mjumbe wrote:

29 October 2007-- oh, how soon they forget... remember this one...its still availed at the US FRB website "Testimony of Chairman Alan Greenspan Private-sector refinancing of the large hedge fund, Long-Term Capital Management Before the Committee on Banking and Financial Services, U.S. House of Representatives October 1, 1998 -

Mr. Chairman and other members of the Committee, I thank you for this opportunity to report on the Federal Reserve's role in facilitating the private-sector refinancing of the large hedge fund, Long-Term Capital Management (LTCM). In my remarks this morning, I will attempt to put into some perspective the events of the past few weeks and discuss some questions of importance to public policy makers that they raise.

The Federal Reserve Bank of New York's efforts were designed solely to enhance the probability of an orderly private-sector adjustment, not to dictate the path that adjustment would take. As President McDonough just related, no Federal Reserve funds were put at risk, no promises were made by the Federal Reserve, and no individual firms were pressured to participate. Officials of the Federal Reserve Bank of New York facilitated discussions in which the private parties arrived at an agreement that both served their mutual self interest and avoided possible serious market dislocations. Financial market participants were already unsettled by recent global events. Had the failure of LTCM triggered the seizing up of markets, substantial damage could have been inflicted on many market participants, including some not directly involved with the firm, and could have potentially impaired the economies of many nations, including our own..." Fast forward, my brother Mr. ONeal may be the sacrificial lamb for ML woes but he is by no means the sole architect of them. That burden lies with the greedy ones slightly below who structured the CDOs from repackaged mortgage debts as well as the central banks [sponsors of printing the liquidity of no value - dollars, pounds or euros take your pick]. And what do current events have to do with the LTCM hedge fund bailout of October 1998? Simple it is basically the same scenario but a different product. Credit derivatives or CDOs select your poison. The US Federal Reserve rushed in 1998 to bailout LTCM due to the players within the investment pool of LTCM and the losses they stood to lose as well as the loses of some foreign government treasuries - a relatively small sector of the overtly weathly. The current malaise of which ML is a minor part is much larger since it involves the average man on the street all the way up to central banks and it rests on the most basic asset for a human - shelter. The greed of extracting artifically generated wealth from primary shelter in the western world via over inflation pricing to sustain "lifestyles" generated the "flipping real estate for profits game" that spawned the greed of local bankers trying to extract a profit with increasing mortgage lending [requiring more capital infusion from central banks], spawning the local banks to work with investment to repackage and resell primary mortgages as CDOs [to keep their capital requirement contra risk exposure in check] and these on computer chip value-less instruments began their little music chairs dance all around the world within the capital markets. Problem what happens with the local bank and the investment bank are somewhat connected via M&As. Who then to acquire and hold the worth-less CDOs. Game over, thus open the flood gates and the ponzi scheme's exposure runs like blood in the streets. Who benefits and who loses? The central banks can always print money of no value so the little man loses via repossessions by the local banks. The local banks and the investment banks have laws allowing for write-offs of these minor bumps post a little media blitzing dog and pony show of sacrifical lambs but who cares if the 200K or 100 quid the average man took out on his/her primary adobe on a refinancing has been absorbed down to less than 40K or 20 quid via a new package where the interest rate is spiralling beyond his/her means to continue to meet the repayments and thus foreclosure looms on the horizon. And, foreclosure is the first step to homelessness. Next lesson the burgeoning global expansion of the non-saving working poor formally know as middle classes in the western economic world. The yarn about global capital credit crunch is a lie. Central banks are withholding the printing of more pounds, dollars, etc. because if they did that the recession down the pike post the iraqi malaise would be a full on global depression -just the thing that the major global banking and insurance sector and the global customer spending giants cannot afford.

  • 19.
  • At 02:03 PM on 30 Oct 2007,
  • Peter Abatan wrote:

Since the risks for these mortgage loans are sold on to 3rd parties like ML, having realised the impact that this has on their bottom line, does this not mean banks that sell mortgages will have to own 100% of the risk associated with that loan?

If this is the case expect to see less favourable bank financial results over the next year or two. Also expect a deluge of new financial instruments to hit the market over the next 2 to 3 years to replace existing ones that have failed.

  • 20.
  • At 06:34 PM on 30 Oct 2007,
  • Oren Vinishavsky wrote:

What needs to be understood about Merrill fiasco is that Stan O'Neil is trying to hide behind the shield of stupidity.
He is not stupid. He knew exactly what he was doing.
He provided money to the minorities which they could not get in any other way. The people who lost money are mostly white. Stan O'Neil does not care about such people as long as he can help his brothers.
It was a redistribution of the wealth, pure and simple.
Do not anybody to tell you otherwise.


  • 21.
  • At 08:01 AM on 31 Oct 2007,
  • Derek Farmer wrote:

I am an old-fashioned banker with almost 35 years experience in the markets.
The rise of the so called "Investment Banks" to global proportions is a relatively recent phenomenon.
Previously, the world's "Merchant Banks" operated on a very much reduced scale of operation.

The faults in the recent debacle lie squarely with the Regulators, who take far too lenient a view of the treatment of "off-balance-sheet" instruments.
In fact it is likely the case that Regulatory Heads do not understand the extreme risk complexity of the plethora of "off-balance'sheet" credit instruments invented by mathematicians and quantitative analysts employed by many Investment Banks today.
Such instruments, in my book, have little to do with banking.
They are a form of speculative investment and there is no way that any public funds should ever be provided to bail out institutions whose investment foolishness leads to financial losses.
The world's bankers should get back to their basic duties of assisting national/global economies and desist from the temptations of spinning and inventing instruments of dubious usefulness to be sold to the gullible for vast profit.
Such people ae not bankers.
They are charlatans.

  • 22.
  • At 12:12 PM on 31 Oct 2007,
  • Robbie wrote:

Departed Merrill Lynch chief executive Stan O'Neal is to pocket a non-toxic retirement package worth $161.5m (£78m).

Nice to see incompetence paying so well!!!

  • 23.
  • At 07:57 PM on 31 Oct 2007,
  • anonymous wrote:

The fed's decision to cut interest rate again , is an act of bailout. The US economy is reasonably strong, unemployment rate is low, corporate earnings (except the financial sector) are ok, the stock markets are around 6% lower than their peaks.Clearly the fed's decision is irrational.This would kill the weak dollar and hit small savers and help fuel inflation.

  • 24.
  • At 08:35 PM on 31 Oct 2007,
  • Colin Smith wrote:

"Such people ae not bankers.
They are charlatans."

Interesting point of view from a banker with "35 years experience" ...

Bankers creation of money increases the supply of said money (currently 15% per annum) far beyond the growth rate of the real economy, which, causes huge amounts of inflation. Housing markets, stock markets are all inflating through massive increases in money supply. What this does is move value from those who earn cash, hold their value in cash to those who own assets like houses and stocks.

When a banker creates some money through a loan, it takes a little bit of value from every other bit of money in the economy. It's really no better than theft, banking is little better than counterfeiting, though of course quite legal.

I was given a one pound premium bond when I was a child. Today, that one pound bond is close to valueless, 95% of the value has been taken by bankers.

So, pardon me if I don't particularly respect the thoughts, opinions and point of view of a banker. Banking is not and never has been an honourable profession. Quite the reverse.

  • 25.
  • At 10:33 AM on 01 Nov 2007,
  • rcrobjohn wrote:

Sadly this may be but the tip of the iceberg. It is alleged that another global investment bank has lost in the region of $40 billion. The total global cost could be in the order of $2 trillion. If correct we will see certain high street names disappear over the coming year and these will make Northern Rock look like the corner shop in comparison. I depend on a strong financial sector to make my living so I hope my contacts are very wrong.

  • 26.
  • At 04:38 AM on 09 Nov 2007,
  • Leon Williams wrote:

What does this 'Credit Crunch' mean for the average investor with pension funds / investments in global stock markets ? SWITCH INTO CASH FUNDS, TAKE YOUR PROFITS AND SIT TIGHT - that's what !

The received wisdom of not trying to call the markets and sitting it out; is not a wise option in this environment I believe. The evidence of what is about to come is there for all to see.

We sometimes neglect to remember that markets crash at our peril.

Hold on tight !

  • 27.
  • At 11:00 AM on 13 Nov 2007,
  • ABB wrote:

Since excessive and cheap credit has got the banks
into this mess, why does Mr Peston think that a rate cut and more cheap credit will get us out of it?
Surely interest rates need to rise to soak up some of the excess liquidity out there.

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