How John Thain Lost $15 Billion

The John Thain tenure at Merrill/Bank of America (BAC) ended yesterday, done in (according to CNBC and other report) by over $1 million in interior design expenditures for his New York office, and $15 billion in losses in the fourth quarter.

It has mystified some how Merrill could have lost so much in such a short period of time. Here are several factors which could have led to the red ink.

As a broker dealer, Merrill was responsible for maintaining inventories in various markets. Given what happened in several of those markets, it may have lost money both on long positions, and in failed hedges against them. Merrill’s balance sheet as of Sept. 26, 2008 is here.

Note that it was long $35 billion of equities and convertible securities. We know in retrospect that convertible markets were decimated in the credit crisis. Converts were particularly hard hit as the historic ratio of equity shorts per bond proved less than what was needed to avoid losses.

Corporate bonds and preferred stocks totaled $39 billion. We know in hindsight that credit spreads widened sharply, and non-governmental paper fell in value.

Mortgages and mortgage-backed securities totaled another $19 billion. Unnecessary to comment given recent history.

Another $17 billion was held in non-US governments, agencies, and US government agencies. In all likelihood a good slug of this was in Fannie Mae or Freddie Mac.

Finally, $7 billion was in municipals, money markets and commodities.

To understand the full extent of Merrill’s problems, it is important to consider most high-grade corporate and MBS/ABS paper trades for spreads over treasuries of the nominal similar maturity. (ABS durations depend on prepayment speeds, delinquency charge offs and other factors.) Completing a purchase of corporate bonds, for example, a Merrill trader would buy $5 million of an industrial company’s bonds and sell short the same amount of US Treasurys. The same would be done by traders of other interest rate paper.

Just shy of $100 billion of receivables under securities borrowed transactions was carried on Merrill’s books. To the extent this was Treasury debt sold short, it may have represented several billion of losses as credit spreads exploded. That is, the short market value of Treasuries went up, while the long market value of non-Treasuries went down.

The sharp fall in rates paid on the short end of the yield curve may also have hurt the firm. That is: proceeds from short sales come back onto Merrill’s book and earn some or all of the interest on those proceeds. In another environment there might have been a positive carry to the primary broker, but with short term rates approaching zero, the short positions might have been somewhat less profitable than in years past.

All of the above ignores such factors as the worsening net interest margin as Merrill’s cost of funds grew while return on funds did not. It is simply an attempt to explain via the balance sheet how the firm could[ have lost so much so quickly.

As an aside, the scramble by market players such as Merrill to cover losing short positions may well have led to the sharp rise in Treasury bond prices. One more reason as things return to normal that the TBT should outperform.

Disclosure: Long TBT.

Comments

[WMBANZAI7:]

Banker Conversations
(WilliamBanzai7)

KEN: Nice carpet John, should I take of my shoes?

JOHN: Use the slippers by the door.

KEN: I hear their selling Bernie's fleet. Some nice hardware there.

JOHN: The guy is a seedy low life crook, he belongs behind bars.

KEN: Come on John, don't be so hard on the man. He's like all of us in a sense.

JOHN: Have a seat KEN (Pointing to COMMODE ON LEGS)

KEN: Man this place make my digs look like a Japanese bankers office.

JOHN: (Sitting in George the IV Chair) Dozo Ken-san. Every Wall Street Shogun has his castle.

KEN: So you got your bonus after all?

JOHN: How so?

KEN: You gave it to all your friends down the hall and spent the pre-installment on this fancy french hardware.

JOHN: You like that eh? It's what we in the business call an AIG omelet.

KEN: You know John, I think I am going to go over and have a look at Bernie's fleet.

JOHN: Shall I join you. You know China Fun is just down the block from his place.

KEN: No John, you stay here and pack this stuff up while I'm gone.

JOHN: Pack?

KEN: Yes, pack. I want you on the street by 5 PM.

JOHN: I don't even have any shrink wrap!

KEN: The only shrink wrap you need is Dr. Schadenfreude rapping the "Bailout shuffle"

JOHN: See you in bailout hell Ken.

KEN: We are already there John. We are already there.

[One hour later]

BERNIE: Ken, you have my sympathy. People just don't appreciate the Ponzi business model in all its subtle manifestations.
Don't feel taken.

KEN: Skip the sermon Bernie, I'll take em all.

Jan 23 07:09 AM

[frs:]

J. Thain = arrogant, greedy jerk. Good riddance.

Jan 23 08:32 AM

[GregO:]

BOA...(snakes)...a large predator that squeezes the life from its prey before consuming it.

Snake: Apple anyone? Go on, take another bite, it's good for you...and there's plenty for everyone. Look, I'll even take the first, bite (200,000 shares) See... it's good for you!

Jan 23 08:54 AM

[JET1C:]

I don't know. Where did all of this come from? I just finished working for 47 years and I got a bonus from time to time, you know, $1000, $3000, once I even got a $5000 bonus for the work that I did durning the year and my contribution. It is beyond my imagination the a guy, even the CEO of a major investment back, who makes several mil per year could earn a $15 mil bonus. I even heard that he paid his driver $280K per year. How much did he give the pions under who worked on the floors below him?

The arragance of these jerks is incomprihesable. What happened to the Board of Directors? Don't they over see things like this? Oh, I forgot, they are CEO's too. They all get the same benefits.

Meanwhile, the share holders get a $ .03 dividend. When I grow up I want to be a CEO.

Jan 24 03:20 PM