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You really can fool all of the people all of the time (or so it would seem). Writedown after writedown, lies and more lies: and yet, Wall Street believes in the Investment banks. The DJIA was up over 266 points yesterday!

"Fool me once, shame on you. Fool me ten times, shame on me." Investors just don't seem to get it yet.

On Thursday 17th July, 2008, Merrill Lynch lost $4.9 billion for the June quarter.
John Thain (Merrill's CEO) reiterated his stance that Merrill did not need to raise more capital by selling equity.

12 days later, a stock sale is announced, Yes, they need more capital again. Meanwhile, Mr. Thain is also looking to sell stake in Merrill’s valuable assets (Bloomberg LP and BlackRock Inc) to raise capital.

I say:

Merrill sold some $30.6 billion worth of toxic CDOs at 22 cents on the dollar.

  • Firstly, after Merrill Lynch, who’s going to be next
  • Did the CDOs turn toxic overnight or in the last 12 days since the June quarterly result. $ 0.6 billion -> $ 11 billion at the end of June -> $6.7 billion yesterday.
  • Was the sale triggered by the undercapitalized bond/ CDOinsurers who could not pay up?
  • Was the sale cheaper than marking them to market (since the really toxic stuff may have no market) which may have triggered more confusion and asset fire sales?
  • What is the market value of the ‘toxic securities’ of Bear Stearns that the Fed now holds; not 22 cents on the dollar, I hope??

Wall Street Credibility and Downside Protection for Sovereign Wealth Funds

Yesterday, a further $ 8.55 billion stock sale was announced, including a stock sale to Temasek (an investment company of the Government of Singapore).

Thanks to a downside protection clause, Temasek will be compensated for the nearly 50% loss suffered on their December 2007 ‘bailout investment’ in Merrill Lynch.

As per the clause, if Merrill raised more capital in the 12 months following the Temasek deal, at a stock price of less than $48, Temasek would be compensated for the difference.

The Wall Street Journal calls it a "sweet deal" for Temasek.

I would call it street smart investing.

When you must deal with someone whom you cannot trust completely, like bankers that just can’t be truthful and disclose to you the true value of their assets and liabilities: you protect yourself.

This is definitely going to set a precedent, as new capital becomes more expensive and comes with many strings attached.

Worse still, as investment banks look to dump toxic CDOs and avoid mortgage related securities, the slowing MBS market is going to result in the unwillingness of banks to lend to the residential housing market in the US.

If you are looking to buy the US Financials, now that the worst is behind us - caveat emptor.

Disclosure: none

Source: Merrill Lynch: On Wall Street Credibility and Sovereign Wealth Capital