Friday, November 2, 2007

Merrill Parking Its Bad Subprime Loans?

Everyone is waiting for the other shoes (plural) to drop at Merrill, including an accurate count of its subprime losses, which are expected to go higher.

Reuters posted a story this morning with the headline "Hedge Funds deals postpone Merrill losses" which references a Wall Street Journal story that claims that a hedge fund bought $1 billion in commercial paper issued by a Merrill-related entity containing mortgages, and the hedge fund had the right to sell back the commercial paper to Merrill after a year for a guaranteed minimum.

I obviously don't know if the story is true, but if it is, that transaction sure sounds like parking or a wash trade, and if a broker on a trading desk entered into such a transaction, FINRA would be all over him. Parking is illegal, you cannot sell a security to your buddy, and promise to take it back from him later at an agreed price. That is a fraud, and the SEC and FINRA are very aggressive about prosecuting such frauds.

Or are they? Merrill must be under extreme pressure to take a write-down if the entity was unable to sell the commercial paper to other investors and suffered losses. If this story is true, the parking transaction lets Merrill delay recognition of the losses for a year.

The WSJ article claims these types of trades are happening with increasing frequency as firms try to address their subprime losses, but does that make it legal? I have been involved in a number of parking cases, most of them involving a trader's attempt to "address" losses in his portfolio. For whatever portfolio reasons, a trader has another trader "do me a favor, hold this position for me." The second trader buys the position from the first trader, and the first trader takes it back from him some time later. If it goes down that way, and there is an agreement as to price, it is a park, and illegal.

Reading the WSJ article, the transactions that are being discussed sound like the exact same type of trade, dressed up by a big brokerage firm name, and an agreement to buy the paper at an "auction" or to give the first broker a mandatory call.

Nonsense. If a small firm or individual trader did this, its a fraud. Why is it any different when Merrill does it?
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