Forced Margin Calls and Chicken Littles

Do you remember when the CNBC crowd was telling us everything is rosy, Cramer was singing you buy high and sell higher, while Mozillo was pumping and dumping CFC on the Kudlow show? That was when the confused blogging chicken littles said the sky is falling. Well, the sky didn't begin to fall until summer 2007, and it still has a long way to crash so don't fall for the recovery in 2008 BS the media is spreading like warm butter on day old bread. Better take a refresher course on how the subprime mess oozed its way into the stock market, your retirement fund and beyond. Here is a quick summary from Bloomberg.

In Unforgiven Margin Call, Bear Funds Failed on Merrill CDOs
By Yalman Onaran

Jan. 3 (Bloomberg) -- From 2005 through the middle of '07, two of Wall Street's oldest firms were locked in an embrace that proved damaging to both.
Merrill Lynch, founded in 1914, sold hundreds of millions of dollars worth of collateralized debt obligations to hedge funds run by Bear Stearns, started in 1923.
Some 90 percent of the face value of the CDOs was loaned to Bear by Merrill, as is normal in such transactions. When the prices of the funds' CDO holdings started to fall in June, Merrill demanded that the firm increase collateral in what's known in the debt markets as a margin call.
Bear Stearns executives pleaded for time, arguing that the forced sale of their assets would push down all CDO prices. Merrill Lynch officials brushed off the entreaty, according to people involved in the discussions.
In June, the hedge funds, run by Ralph Cioffi, sold $3.8 billion of CDOs to meet margin calls by Merrill and other lenders that were following its lead. The fire sale led to a further drop in CDO prices.
Among those that lost value: $23 billion of CDOs Merrill held on its own books. In October, Merrill wrote down the value of all of its mortgage-backed holdings, including CDOs, by $7.9 billion and declared a loss for the third quarter.
``It was in Merrill's interest to wait it out and allow the Bear Stearns funds to recapitalize, so they wouldn't have to re- price their assets,'' says William Fitzpatrick, a financial services analyst at Racine, Wisconsin-based Optique Capital Management, which oversees $1.7 billion. Optique held both Bear and Merrill shares; it sold all of its Merrill shares in 2006 and dumped its remaining Bear shares in July, Fitzpatrick says.
$850 Million Seized
Both Bear Stearns and Merrill Lynch declined to comment on the matter. Merrill is a passive, minority investor in Bloomberg LP, parent of Bloomberg News.
On June 15, Merrill Lynch seized $850 million of the CDOs from Cioffi's funds -- as lenders are allowed to do when their margin calls aren't met -- and tried to sell them in the market. When the firm received bids of 20 cents on the dollar, it abandoned the effort. In July, Cioffi's funds declared bankruptcy, losing $1.6 billion of investors' money and triggering the repricing of CDOs around the world.
Giving Bear Stearns a chance to shore up the hedge funds might have allowed time for Merrill Lynch to reduce its CDO portfolio or buy hedges against it, Fitzpatrick says. In June, before the funds' problems became public, there were market players who were still willing to underwrite credit default swaps on CDOs. That opportunity disappeared after the Bear funds' failure.
``The end was inevitable,'' Fitzpatrick says. ``But Merrill could maybe have bought some time if it hadn't blown the whistle on the Bear funds.'' Divorce might have been in order. Merrill filed its petition too soon.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aT2LrbPYb7wU&refer=exclusive