Street In Denial About CDOs And Other Balance Sheet Junk (MER)

When Merrill Lynch (MER) off-loaded $30.6 billion worth of CDOs for 22 cents on the dollar last month, the market rallied. The deal gave investors an idea of where the bottom was, and the market thought other banks would follow in Merrill’s footsteps and dump risky assets. But they haven’t.

Reluctant to hurt capital positions and horrified by the thought of selling at the bottom, banks and brokers have just held on to their mortgage junk–on the theory that market conditions will improve and they’ll ultimately be able to get more for them.

This strategy could backfire. The housing crash has a long way to go, and, to paraphrase Keynes, the market can stay nuts a lot longer than banks can stay solvent (and that’s assuming the market is nuts, which is a big leap).

Maybe banks will be able to fetch better prices for their mortgage assets at some point. In the meantime, however, they’re rolling the dice. Assets that are perceived to be solid–prime mortgages, commercial real-estate loans, corporate loans–are now starting to deteriorate, and the banks’ capital positions could soon be threatened by assets that have nothing to do with CDOs. Which is all the more reason for banks to dump the CDOs when they can, as opposed to when they have to, and put the worst of the mortgage mess behind them

See Also: Frustrated John Thain’s Merrill Losing $52 million a Day
Merrill (MER) Deal: Check Out the Scary Fine Print

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