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Wednesday, July 30, 2008

Banks and CDO pricing

Why does Merrill's CDO sale make such headlines? In the NY Times we have this:

The fire sale raises a troubling question for the nation’s battered financial industry: Have other banks with similar investments overestimated their values?

Still, Merrill’s price of 22 cents on the dollar was held up as the new measuring stick on Tuesday, as analysts whipped out predictions for Merrill’s peers. Several focused on Citigroup, a bank with large exposure to C.D.O.’s.

An analyst from Deutsche Bank said the new marks might cost Citigroup up to $8 billion. An analyst from Merrill Lynch said the write-down at Citigroup would probably be closer to $6 billion. And at Ladenburg Thalmann, an analyst said the marks would be much smaller. Citigroup declined to comment.

Citigroup’s chief financial officer said on the company’s second-quarter earnings call that many of the bank’s C.D.O.’s were created before 2006. Those assets are valued at 61 cents on the dollar, for now. Other mortgage assets at Citigroup known as mezzanine C.D.O.’s and high-grade C.D.O.’s are already marked closer to Merrill’s 22-cent level.

An analyst from Deutsche Bank said the new marks might cost Citigroup up to $8 billion. An analyst from Merrill Lynch said the write-down at Citigroup would probably be closer to $6 billion. And at Ladenburg Thalmann, an analyst said the marks would be much smaller. Citigroup declined to comment.

http://www.nytimes.com/2008/07/30/business/30merrill.html?_r=1&ref=business&oref=slogin

So a fire sale is the new measuring stick? Boy that is completely FASB!

Look how the bears chimed in with their "what if" scenarios.

William Tanona, Goldman Sachs analyst, said that if Citi were to write down its $22.7bn of CDOs to the levels implied by the Merrill deal, it would have to take a $16.2bn writedown. Citi said this month that it valued its CDOs at about 61 cents on the dollar. Citi declined to comment. However, people close to the company said that the bulk of its CDOs dated to years prior to 2005 – before the onset of the housing crisis. As a result, they said that Citi was comfortable valuing them at current levels.
http://www.ft.com/cms/s/0/b38320c8-5d99-11dd-8129-000077b07658.html

Here's a question. If we know a buyer wants to pay 22 cents on the dollar for Merrill's most toxic CDO's, and we know that Merrill has lost more money than anyone, why would anyone think that Merrill was getting the better price than the buyer?

They weren't.

And if these structure squared ABS CDO's were so complicated, how is that we can have estimates of their value, when the people estimating their value don't know what they own?

They can't.

But at 22 cents on the dollar, what is the upside for those that are short? There isn't any. And since these markets are so thin, what will the short covering cause?

Higher prices on even the most toxic junk.

At least the most over-hyped CEO on the face of the planet is good for something.

John Thain gave us the bottom in pricing!