As conditions degrade from bad to worse at many Wall Street firms, the public is occasionally treated to explanations of Why Things Went Amiss. But firms usually provide detail only when they believe they can get persuade their chump shareholders that the problem is behind them.
According to Morgan Stanley, the problem was stupid traders:
Part of the losses stemmed from derivative contracts the firm’s proprietary trading unit wrote earlier in the year, [Colm] Kelleher [Morgan Stanley’s chief financial officer] said. The traders anticipated a decline in the value of subprime securities, and the contracts made money for the firm in the second quarter, he said. They started losing money when prices fell below the level the traders had anticipated, Kelleher said.
“These exposures did not come out of our client-facing activities, these were a proprietary position we put on,” Kelleher said in a conference call with analysts today. “As markets continued to decline our risk exposure swung from short, to flat to long.”
The people responsible for the losses no longer work at the firm, said Morgan Stanley spokeswoman Jeanmarie McFadden.
I hope “responsible” is rather broadly defined. Anyone who can make the right directional call, sell a derivative that enables him to lose anyhow (probably a no-cost-to-the-buyer type, for example, with floors and ceilings) and gets management to sign off on it is pretty special. Whoever was overseeing the people who executed this strategy should also have been shown the exit.
Merrill, by contrast, has the embarrassment of explaining how they lost the loss. Merrill has ascertained that they have $6.3 billion more in subprimes than they fessed up to in their quarterly report. While the financial statements in 10-Qs aren’t audited, this level of adjustment is, ahem, quite unusual and makes one wonder what other ugly things might come crawling out from under the rocks. Oh, and Merrill also found a failed hedge that increased its CDO exposure by $600 million.
Merrill Lynch & Co Inc. on Wednesday said its total exposure to risky collateralized debt obligations and subprime mortgages is $27.2 billion, or about $6.3 billion more than what the company disclosed late last month.
Merrill’s larger figure is mostly because of a deeper level of disclosure surrounding its banking operations. For the first time, the world’s largest brokerage disclosed $5.7 billion worth of exposure to U.S. subprime mortgages at Merrill Lynch Bank USA, a Utah-chartered industrial bank, and Merrill Lynch Bank & Trust Co., a full-service thrift.
Those operations file disclosures and financial statements with U.S. banking regulators, which don’t require details on subprime exposure.
In addition, Merrill said its exposure to CDOs is now $15.82 billion, or about $600 million more than what the company revealed in its third-quarter earnings release on October 24. The figure is larger because a hedge against potential loss was terminated recently after a dispute with a counterparty, which Merrill declined to name. That meant additional exposure went back to Merril.