Sunday, August 3, 2008

Nouriel Roubini on Merrill's CDO sale to LoneStar at .22 cents on the dollar

Merrill Lynch decision to “sell” a good chunk of its remaining CDOs at 22 cents to the dollar has been widely praised as the firm finally recognizing the full extent of its losses on these toxic instruments. This batch of $30.6 billion of CDOs was already marked down to $11.1 billion. Now with the “sale” of it to Lone Star at a price of $6.7 billion Merrill Lynch is taking another $4.4 billion writedown and “selling” it at 22% of the original face value.

But is this a market-based “sale”? No way as calling this transaction a “sale” is a joke. Let me explain next why…

First, note that the secondary market for CDOs is now extremely illiquid and Merrill will provide financing for 75% of the purchase price, or a financing of $5.055 billion. That implies that these CDOs are worth much less than 22 cents of the dollar. These type of “sales” transactions – broker dealers “selling” their toxic waste at a discount and providing hedge funds and private equity funds with heavily subsidized financing for it – has going on for a while. That discounted “sale” price often ends up being much higher than the true value of the assets...

So, based on the above consideration, is this toxic junk worth 22 cents on the dollar? No way and one would have to assume that the true market value of this garbage is closer to zero than 22 cents. So the street is now arguing that 22 cents on the dollar sets a market benchmark for writing down CDOs (Citi is still carrying them at a value of 53 cents rather than the 22) and many other firms will now have to use this benchmark; but the reality is that this toxic garbage is worth much less than 22 cents. So the charade of pretending to mark down to market the value of this junk will continue for a few quarters with continued bleeding of earnings.

So Lone Star just pissed away $1.75 billion? That's what you would have to believe if you listen to Roubini. Merrill Lynch, which lost $47 billion, now took $1.75 billion from Lone Star, in one of the shrewdest trades in recent memory.

Would you rather bet with John Thain or against him? That's the only answer you need!

Mark everything to zero, because we are going to have a worldwide collapse, second only to the depression.

Doesn't anyone find it just a bit disingenuous that these bears proclaiming that this paper is worth zero don't even know what it consists of?

Remember Roubini's viewpoint of this economy is the following:

The only question is how severe, nasty and protracted. And the answer is long, nasty and severe with credit losses ending up being closer to $2 trillion rather than $1 trillion, home prices falling at least 30% and wiping out $6.6 trillion of housing wealth, 40% of households ending up into negative equity in their homes and up to 50% walking away from these homes, a 40% fall in equity prices and a banking crisis where hundreds of small, regional and national banks will go bust.

So half of all homeowners are going to walk away from their homes? Who are they going to rent a house from?

Tomorrow, we should get a SEC filing from Merrill Lynch, indicating the terms, and the makeup of the CDO's that they sold.

But the scare tactics are needed today. The bears can't let the facts get in the place of a good story!

The bears have "lost their marbles."

They need to read this post!

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