Toomre Capital Markets LLC("TCM") has previously written about Jeff Kronthal Returns to Merrill Lynch and the absolutely abysmal performance put in by former CEO Stan O'Neal in the TCM post Merrill Lynch's Stan O'Neal: Why Is He Even Still Employed? Ahead of Merrill Lynch's expected announcement of abysmal first quarter earnings, on Wednesday April 16^th 2008, The Wall Street Journal ran a front page story written by Susan Pullman (and others) entitled Merrill Upped Ante as Boom in Mortgage Bonds Fizzled. While the article sheds favorable light on Merrill Lynch's new CEO John Thain and (old TCM friend) Jeffrey Kronthal since their respective arrivals in December 2007, the article absolutely savages the former Merrill Lynch fixed-income and senior management. With the expected total write-downs now expected to approach $30 billion, it is very clear how absolutely out of control Merrill Lynch truly was since mid-2006 when Jeff Kronthal was famously relieved for not taking enough risk in the Collateralized Mortgage Obligation ("CDOs") business.

This article explains Merrill Lynch "revved up its production of complex debt securities -- despite a shortage of buyers for them -- in what turned out to be a misguided effort to limit its losses. Its torrid underwriting loaded Merrill with exposure to mortgage securities, whose top credit rating provided scant protection when investors fled. Then Merrill made another fateful move: trying to hedge some of its massive mortgage risk through bond insurers whose strength was questionable." Now among those that are keenly interested in learning what went wrong and when the Merrill Lynch managers knew the extent of their troubles is the Securities and Exchange Commission ("SEC"), which "is examining whether Merrill and other firms should have told investors sooner about the stumbling mortgage business last year."

From the article, in 2006 risk controls at Merrill Lynch were beginning to loosen. Apparently a senior risk manager, John Breit, then the head of market-risk management, was ignored when he objected to certain underwriting risks. It is suggested that as a result, senior Merrill Lynch management then demoted the head of market risk management position within the management hierarchy lead to Mr. Briet's resignation. The article continues,

"Some managers seen as impediments to the mortgage-securities strategy were pushed out. An example, some former Merrill executives say, is Jeffrey Kronthal, who had imposed informal limits on the amount of CDO exposure the firm could keep on its books ($3 billion to $4 billion) and on its risk of possible CDO losses (about $75 million a day). [TCM emphasis added] Merrill dismissed him and two other bond managers in mid-2006, a time when housing was still strong but was peaking.

To oversee the job of taking CDOs onto Merrill's own books, the firm tapped Ranodeb Roy, a senior trader but one without much experience in mortgage securities. CDO holdings on Merrill's books were soon piling up at a rate of $5 billion to $6 billion per quarter. This led to an inside joke at Merrill. Mr. Roy is known as Ronnie. Some employees took to saying that if they couldn't find a specialized bond insurer, known as a "monoline," to take Merrill's risk on the deal, they could resort to a "Ronoline."

Mr. Roy, whom Merrill asked to leave five months ago, says he was simply following orders in loading the books with mortgage securities and that he objected to the practice. He is now at Morgan Stanley.

In August 2006, one Merrill trader fought back when managers pushed to have the firm retain $975 million of a new $1.5 billion CDO named Octans. In a meeting in the office of a risk manager, the trader argued against keeping the securities on the books.

The result was a heated phone conversation with Merrill's CDO co-chief, Harin De Silva, who was out of the office. Mr. De Silva urged the trader to accept the securities, while the trader said he didn't know enough about the CDO to feel comfortable doing that, say people familiar with the meeting. Mr. De Silva reasoned that Merrill would bear less risk by taking on the super-senior tranche because it had already found investors to take on the riskier slices. The alternative was to let the deal fall apart, which would leave Merrill holding the risk of all the securities that would have backed the CDO.

In the end, Mr. Roy's group took the $975 million of securities on the firm's books. That meant Merrill could complete the underwriting of the Octans CDO, a step that helped the firm hold its top rank in CDO underwriting and led to an estimated $15 million in fee revenue for the deal, according to people close to the situation.

Boy would not the stakeholders of Merrill Lynch wish today that Stan O'Neal had listened when the experienced risk and trading managers spoke up about the risk in CDOs! Instead, he effectively decapitated them! No wonder "Merrill's new CEO, Mr. Thain, is seeking to regain investors' trust by upgrading the firm's risk controls. In one move, the firm in December rehired Mr. Kronthal, the risk-conscious bond executive Merrill had let go in 2006 when it was determined to increase its bet on CDOs. His new job: to help Merrill clean up its CDO mess."

Toomre Capital Markets LLC wishes Mr. Thain and Mr. Kronthal well as they attempt to clean up the mess of the previous eighteen months. As for the former senior management, may the wrath of investors and the regulators do what they did to Mr. Breit, Kronthal and others: decapitate them and hold them financially responsible for the utter recklessness with which they managed (and almost destroyed) a major investment bank.