What Merrill Means for MaineFail

When a shaky investment falls in value while no one's looking, does it still make a sound? Answer: only when it's time to sell. Earlier this week investment bankers up and down Wall Street began complaining about some serious ear-ringing at the exact moment that Merrill Lynch announced an impending sale of impaired assets at 22 cents on the dollar.

The mortgage-backed securities on Merrill's balance sheet are on everyone else's, too. Ever since the credit crisis began last August, there has been a tacit code of silence among the players: whatever you do, don't let on as to what these securities are really worth. Write these down gradually, a few billion this quarter, a few more the next. What we need is time to wriggle our asses, sorry, assets out of this mess.

Merrill has broken that code. (You may now cue up the Chambers Brothers' "Time Has Come Today--TIME!") Thanks to Merrill, there is now a market to which these assets can be marked, triggering massive write-downs throughout the industry. "Merrill Lynch converted its mark-to-market losses into permanent ones," noted investment strategist Ed Yardeni in an e-mail to clients Tuesday. "This is bad news for other investment banks and commercial banks trying to get rid of loans and securities in a market flooded with distressed assets."

Which brings us to Maine's failed investment in MainSail II. Yesterday Maine's Treasurer, David Lemoine, posted an update on the State's cash pool. Because accounting rules required a "valuation snapshot" of the MainSail investment on June 30, or fiscal year's end, consultants used their magic dartboard to come up with 33 cents on the dollar. That meant that Maine's cash pool was showing an unrealized loss of almost $13.3 million on that investment. But that was then. If we mark to Merrill, not to magic, we are looking at a paper loss in excess of $15.5 million on an initial investment of $19.9 million.

Let's keep going. Remember that Merrill accepted only 25% down on the sale of the CDOs, or 5.5 cents on the dollar. The loan of the other 75% is secured only by the CDOs themselves, which means that Merrill will get them back if they decline in value by another 25% from here. If you use the down payment as the real market value of such securities, then MaineFail's loss balloons to $18.8 million. Why does it suddenly sound so loud in here?

Lemoine's capsule summary is as good as any. "The market estimate confirms that the U.S. housing market and the worldwide credit markets continue to suffer, and that investors continue to shy away from mortgage-backed investments regardless of their underlying value. The arrival of a bear market on the equities exchanges, ongoing huge bank write-downs, relentless energy prices and inflation fears have stifled investor appetite for fixed-income instruments such as Mainsail II."