Now we’re talking real money. Deutsche Bank’s Mike Mayo reckons Merrill Lynch could face as much as $10 billion (about Rs40,000 crore) in additional write-downs on collateralized debt obligations (CDOs), subprime mortgage bonds and the like. That’s on top of the $7.9 billion that helped trigger the ouster of former CEO Stan O’Neal.
Combined with a report that some Merrill transactions might have attracted scrutiny from regulators, that sent the Thundering Herd’s stock tumbling towards two-year lows. Others are suffering, too. Shares in Barclays and Citigroup, two other big players in CDOs, have suffered heavy declines in recent days.
But it’s not just talk of further write-downs that is fuelling the latest bout of fear and caution in the markets. The real driver is uncertainty. Financial institutions have been wary of disclosing much about their exposure to these wilting securities. And investors have developed a healthy distrust of any numbers they are given. It’s a fragile, even dangerous, situation.
But what’s to be done? The banks could just muddle on. But that would mean waiting another couple of months for the next update on where Wall Street firms stand. Meanwhile, credit markets could remain mired in fear and confusion. Moreover, the pain from recent shoddy mortgage lending might not be over for another year or two.
At the other extreme, the banks could simply write their subprime-related CDO holdings off altogether. Then any value that materializes later is gravy. The trouble with this, of course, is that some institutions might look very shaky indeed if they have to write down billions, or tens of billions, more. It’s hard to see how this could be done without at least the potential for a bailout, if needed.
The third option is for these firms to come clean. If they set out in more detail the exposures they are struggling to value, it would reduce the uncertainty of what is out there. It wouldn’t necessarily mean the securities could be valued definitively, but at least investors would be able to assess the holdings, and discover which firms were using more and less conservative valuation assumptions.
None of these possibilities is particularly attractive, although the last could be the most practical way to start exorcising the demons. Oddly enough, having taken more heat than most and reacted a bit clumsily, Merrill might now be best placed to lead the way. There’s no incumbent CEO who might want to avoid the blame. And any new boss should want to start with the assurance that all the bad news is out.