Sunday, January 25, 2009

Merrill, $15 Billion, and BofA

Zero Hedge blog raises the following question:

Was Merrill Casualty #3 of The Basis Trade After DB Prop and Citadel
Posted by Tyler Durden at 9:48 AM

"In a bet gone very bad, that if true would make Jerome Kerviel's $5 billion loss at Soc Gen seem like amateur hour, the WSJ reports ($$$ link with hat tip to that the main reason for Merrill's massive $15 billion Q4 loss was due to some very large basis trades gone horribly wrong. We wrote briefly about the basis trade here but now with attention turning more firmly to this topic, it is worth revisiting."

If you're a pro, you might find the entire blog interesting and comprehensible. I'm not and don't get most of it. However, here's what I think I do get. Merrill is suspected of gambling on the eve of being sold for $29/share. It had no need to risk scuttling the deal by gambling. Every gamble of this nature has a counterparty taking the other side of the gamble. That counterparty makes an equal profit to the loser, minus transaction costs if any.

In an article titled "BofA had role in Merrill bonuses", The Financial Times reports today that "In the wake of Mr Thain's dismissal last week, sales and trading chief Tom Montag, his top deputy, received a promotion. Mr Montag's department was responsible for at least half of Merrill's $15bn loss in the fourth quarter."

Why promote a loser such as Mr Montag. Did BofA make a profit as a counterparty while Merrill took huge losses?

Even Inspector Clouseau knew that every misdeed needs a motive. The motive here that makes sense is to dump on Merrill to make BofA look good.

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