Hoping Rock Bottom is Near: Merrill Lynch Reports Largest Quarterly Loss in its 93-year History

On October 24th, Merrill Lynch & Co. reported the largest loss in its 93-year history due to the unprecedented write-down of $8.4 billion worth of assets. The write-down is due largely in part to the credit crisis that burst the housing bubble this past summer. This enormous figure, coupled with poor managerial foresight as to the stability of the credit markets, led to the staggering reevaluation of the firm’s assets. The news is just another astonishing blow to an industry that has been beaten relentlessly throughout the third quarter of this year. In just over two months time, it has seen thousands of layoffs (CIT, Bank of America, and UBS), multiple firings of major CEOs (UBS and Bear Stearns & Cos), the write-down of billions of dollars worth of assets (UBS and Merrill Lynch), and the exposure of hundreds of thousands of sub-prime mortgages that will likely default and further exacerbate the tragic state of the market.

There are two critical problems with Merrill Lynch’s recent announcement to reassess and lower the value of its collateralized debt on its balance sheet by writing off the difference as a loss for the quarter. First of all, the fact that the company lost $8.4 billion worth of investors’ money raises questions about its investment policies and its ability to assess risk. Merrill’s credit took a hit by reputable rating agencies due to the irresponsible and negligent amount of its balance sheet that was tied up in risky fixed income securities. Agencies such as Standard & Poor’s, Fitch Ratings and Moody’s Investors Service all lowered their assessments of Merrill’s credit. According to Bloomberg, Standard & Poor’s lowered its rating on Merrill’s senior unsecured debt from AA- to A+, describing the quarter’s performance as “startling” and referencing “management miscues” as the reason behind the losses.

The second problem regards a press release by Merrill Lynch on October 5th of this year that declared that its asset write-downs for the quarter would total $5 billion, a jarring number in its own right, but barely half of the figure released later this month. This gives an insight into seriously questionable management and severe analysis and communication issues. Merrill’s Chief Executive Office, Stanley O’Neal, defended the write-down as a “conservative” analysis of Merrill’s holdings after “misjudging the severity of the decline in debt markets since July.” The excuse has not bolstered investor confidence, as Merrill’s stocks have decreased significantly since the announcement, falling 5.8% on the day to $63.22. Rose Grant, who manages about $2 billion including shares in Merrill, describes its performance as “disappointing.” She adds that she does not “think Stan O’Neal will step down, but you do have to look at top management and wonder why they didn’t know the extent of this loss.” It is certainly no surprise, however, that, given the decline in share value due to the massive discrepancy between estimates less than a month ago and the most recent figures, Merrill Lynch did, in fact, ask Mr. O'Neal to step down.

The terrain is definitely unstable for the large American financial institutions that specialize in underwriting asset-backed securities (selling these mortgages to both public and private investors). On top of Merrill’s stock’s decline, major competitors like Lehman Brothers Holdings (down 1.5%) and Bear Stearns & Cos (down 2.3%) have all seen their stocks decline as the bad news keeps rising. Merrill’s, which has been called “the largest write-down by a U.S. securities firm,” according to Charles Geisst, author of 100 Years of Wall Street, exceeds Citigroup Inc.’s $6.5 billion revaluation this period and pushes the industry-total for the period up North of $30 billion.

As estimates continue to be defied it might be appropriate to ponder the near future of the market. Opinions vary from quasi-optimistic to severely pessimistic. International investor-celebrity Warren Buffet hypothesized that “problems in the U.S. subprime mortgage market will likely be a drag on the U.S. consumer’s buying power for up to two years, but that the U.S. economy will weather the storm.” Nigel Gault, chief domestic economist at Global Insight, said that he expects “consumers [will] reduce their spending by about 6 cents for every dollar of lost wealth.” In other words, if prices drop 5% next year, there would be a $60 billion decline in spending. This would be a significant slowdown but, according to Gault, “not enough to cause a recession.” On the other hand, highly regarded investor and co-founder of the Quantum Fund, Jim Rogers reported to Britain’s Daily Telegraph that the United States has “undoubtedly entered a recession,” citing that “Many parts of [the American] industry are actually in a state worse than recession. If it were not for [Federal Reserve Chairman Ben] Bernanke putting huge amounts of money into the market, the stock market would probably be down much more than it is.”

Regardless of these highly regarded investors’ opinions, it seems safe to say that once again the American economy is in a terrible downward spiral and the proverbial “rock bottom” is nowhere in sight. Millions of Americans will be forced to vacate their homes due to their unaffordable mortgages over the next year and the U.S. housing market will continue to decline. Therefore, it is imperative, someone must take action now. Whether it be President Bush locking in interest rates for adjustable rate mortgage (“ARMs”) borrowers or Ben Bernanke stimulating the economy with a more progressive monetary policy, something needs to happen. This is a cry for action, and the action needs to be now.

Citigroup vs. Merrill Lynch: A Neck-and-Neck Race for the Biggest Losses of All Time

While Merrill Lynch’s massive $8.4 billion asset write-down and release of long time CEO Stan O’Neal may have been last week’s big story, Citigroup captured headlines this week by publicly declaring that in addition to the $6.5 billion write-down for the third quarter, it expects to write-off the balance sheet a total of $11 billion before the year’s end. With the deployment of the awful news, Citigroup’s board of directors appropriately dismissed CEO Charles Prince (seen at right). After searching through related blogs, it is apparent that expectations for the future are far grimmer than analysts predicted this past summer. The subprime mortgage crisis, which was once viewed by skeptics as unlikely, is now approximated by some to be just the tip of the iceberg, with the true meltdown expected by mid-2008. If this proves accurate, Citigroup and Merrill will not be the only holders of subprime debt to feel the wrath of a careless and unmonitored system

Article 1: Memo to Citigroup and Merrill: It’s time to kill the financial supermarket

This is a classic case of how hindsight is always 20-20. Merrill Lynch and Citigroup are merely the first of many large, conglomerated or “supermarket” firms that will suffer from the poor lending practices and exaggerated market appreciation in the early part of the millennium. As noted on Bloomberg, the exposure of bad debt from subprime loans soaking up massive amounts of capital on companies’ balance sheets is the manifestation of poor risk-awareness by these massive firms as well as by the mortgage brokerages. That said, however, the “credit-crunch” is not the result caused by the amalgamation of different financial sectors under one corporate name, but rather, it is the result of lax and ill-considered lending practices by mortgage originators. Admittedly, the blame is, in turn, transferred to the major banks such as Merrill and Citigroup for not performing sufficient due-diligence on the mortgages they were buying, packaging, and selling to investors as CDOs and the like. That said, however, I certainly disagree with the assertion that former Citigroup CEO Sandy Weill (seen at right) is to blame for the subprime meltdown two and half decades after he introduced the financial supermarket. While having various financial sectors combined under one roof may “link” a firm’s banking sector with its investing or lending sector, there is little if any documentation to prove that is actually counterintuitive to a firm’s profitability (which is good for both investors and the firm). Finally, I would argue that if anything, there would be a significantly greater amount of positive synergies arising from the linkage of various financial sectors under one roof due to enhanced communication channels and a uniform corporate vision with intertwined interests and goals. Not to mention that if every big bank were to sell off its individual business units there would in all likelihood be far more units for sale than potential buyers.

Article 2: Poll Shows America Does Not Support Federal Intervention in Sub-Prime Mortgages: FreedomWorks poll shows 62 percent believe individuals should take responsibility

First of all, without regards to this poll in particular, it should be known that polls can be manipulated to show a statistic that favors the agenda of whomever is doing the polling.

That said, the poll used in this article is nevertheless pertinent and indicative of at the very least a minority opinion. The sheer problem with this poll, in my opinion, is that the statistic views federal intervention and federal legislation as synonymous. Currently, the American economy is standing on the edge of a very big cliff caused by the roughly $370 billion worth of outstanding bad subprime debt. As stated in the Money Times, the majority of this debt will be resetting over the next year at a monthly rate twice that of this past year (400,000 mortgages/mo rather than 200,000/mo.). This is why the Citigroup’s and the Merrill’s are suffering so perilously, and this is why the Fed cut interest rates for a second month in a row. Too many Americans bought a house in the last couple years and cannot afford their adjustable mortgages once they reset to a higher rate, while at the same time he or she cannot afford to get out of it (that is, pay off the debt portion of their home since their home's equity decreased significantly as home prices fell over the past several months). This is why federal spending must be increased to provide subsidized mortgages to those who are currently being evicted from their homes and to those lenders whose companies stand at the mercy of the subprime market. This oil spill of a problem the economy has on its hands will continue to spill into other sectors; according to MSNBC, auto sales will slow inversely to the number of mortgages that are defaulting. Also, according to Kiplinger, consumer spending will also be aversely effected as households’ discretionary income is sucked up by their increased house payments. I agree that federal legislation dictating regulations on financial firms’ practices is extreme and not appropriate for the situation on hand. In order for the markets to recover, however, the government must aid the consumers AND the lenders as both continue to feel the negative effects of this credit-crunch.