The bankers and traders dealing in CDOs didn’t understand what they were doing, John Thain said in a recent speech.
“To model correctly one tranche of one CDO took about three hours on one of the fastest computers in the United States. There is no chance that pretty much anybody understood what they were doing with these securities. Creating things that you don’t understand is really not a good idea no matter who owns it,” the former Merrill Lynch chief executive said in a speech this month, according to Financial News.
Felix Salmon blasts him for apparently changing his tune on the ability to understand risk.
“Certainly Thain tried his darndest as CEO to give the impression that he knew exactly what his CDO holdings were worth, and that Merrill understood them very well,” Salmon writes. “So I guess he’s now saying that he was lying?”
We’re not sure that’s really fair. We remember the very first earnings conference call on which John Thain sat. One of the things that impressed us at that time was his candor. He admitted that Merrill had done a very bad job in putting together its CDO portfolio. And he admitted that he coulding really know much about the CDO valuations.
Here’s one exchange from the January 2008 conference call:
Prashant Bhatia – Citigroup: OK. And then, can you give any sensitivity to the cumulative loss assumptions? I think you said 16% to 21%. It’s clearly not linear so if it ends up being higher or lower, can you give any kind of sensitivity there on the impact?
John Thain: The problem is, as you know, that the — it’s very dependent on the deal structure on a name-by-name basis. It’s dependent on the vintage of the mortgages. The 16% to 21% was intended to give you the kind of — the average range that we are looking at.
It’s very hard to get much more detail to that other than — unless you actually run the individual positions. The only thing I would say is we believe that we are being conservative on these marks and we think that at the levels that they are marked, we will in fact be able to sell them and/or that they represent value at where they are marked.
You know, at some point as you mark these things down, they approach their aisle value and they really don’t have as much downside going forward once you get the marks low enough.
We think it’s good news that Thain is now emphasising the knowledge problem when it came to banking–highly paid, well-educated people at the top of their field just didn’t understand the credit derivative products they were buying and selling. This is important as much of our financial reform seems to ignore this problem, focusing instead on fixing incentives in compensation.
It also undermines the idea that the Fed–or any other regulator–will be able to properly assess the risk of these kinds of derivatives.
Could this be Thain’s way back to respectability? Being the guy who will tell the dangerous truths about risk on Wall Street?
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