Like water-torture, the drip, drip, drip of bad news out of Wall Street keeps coming. According to a report in The Wall Street Journal, Merrill Lynch (NYSE: MER) will report mortgage securities write-offs of another $6 billion to $8 billion, raising the question whether the firm will have to bring in more money by selling shares..

The newspaper reports that "The latest would bring its total since October to more than $30 billion and mean that Merrill reports a third straight quarterly net loss." Merrill compounded its problems by getting further into the CDO markets as 2007 went on.

While some experts believe that the worst is behind big banks and brokerages, that may not be true. The paper based on mortgages still carries risk as the housing market continues to fall.

Statements from Wall Street firms about a near-term recovery is a victory of hope over reason. The truth of the matter is that they have no idea how much more the economy will slide. That raises the question of whether home equity loans, credit card debt, and auto loans will begin to fail at a faster rate. There are securities held by banks based on pools of all of this debt. The value of LBO debt could also continue to drop as business profits are squeezed by a poor economy.

The Merrill write-down is a sign of one thing and one thing only. Wall Street's numbers could get much worse and there is little reason that the economy will help them get better.

Douglas A. McIntyre is an editor at 247wallst.com.

The Wall Street Journal is trying to gin up some pity for Alan Greenspan. Apparently his feelings are hurt because people are blaming him for the current economic mess. They criticize him for keeping interest rates at 1% for too long, praising adjustable rate mortgages, and maintaining lax regulatory oversight. But the Journal missed the two key flaws in Greenspan's record -- his love of securitization and his critical support of Bush's $1.3 trillion worth of tax cuts.

Meanwhile Greenspan is raking in enormous bucks. The Journal reports: "His memoir has sold about a million copies. He collects six-figure fees to answer questions for audiences, typically assemblies of financial professionals. He has signed consulting contracts with three firms, including Germany's biggest bank, Deutsche Bank AG; the world's biggest bond-fund manager, Pacific Investment Management Co.; and Paulson & Co., a hedge fund that made billions betting against housing."

In a 2002 speech referring to credit derivatives, he said financial instruments such as credit default swaps, collateralized debt obligations (CDOs) and credit-linked notes have also helped make the economy shock-resistant. "Such instruments appear to have effectively spread losses from defaults by Enron, Global Crossing, Railtrack, WorldCom and Swissair in recent months from financial institutions with large short-term leverage to insurance firms, pension funds, or others with diffuse long-term liabilities or no liabilities at all,"

The New York Times reported a blockbuster revelation from yesterday's Congressional testimony on the JPMorgan Chase & Co. (NYSE: JPM) acquisition of The Bear Stearns Companies (NYSE: BSC). It turns out that the religious right and government bailouts go hand in hand -- that's because Treasury Secretary Hank Paulson decided that he would not put $30 billion worth of taxpayer money at risk unless JPMorgan paid a really low price for Bear.

The reason? Moral hazard. Specifically, Paulson wanted to use Bear as an example that would scare all the other banks that borrowed $32 for every dollar of equity to buy Collateralized Debt Obligations (CDOs) and other difficult -to-value securities. Paulson wanted to wipe out Bear shareholders so they would be reluctant to seek government help if they got into trouble.

And another thing. Alan Schwartz, Bear's CEO, claims to have misunderstood and thought it was a 28-day loan granted on Friday 14th. This would have given him a month to straighten things out. But he later learned that the loan lasted only for the weekend. And he would need to file for bankruptcy or accept the deal that Paulson was offering. Faced with two terrible choices, Schwartz took the Paulson deal.

How much will taxpayers lose due to Paulson's moral qualms? Was this really necessary? Wouldn't the 28-day loan have avoided this?

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

With the Fed rumored to be contemplating a rare 100 basis point rate cut, it's worth considering whether this policy is doing any good. I'd say those rapid rate reductions are doing more harm. Here's why: non-stop interest rate cuts make business lose confidence in the Fed – since those cuts are ineffective – while signaling that economic conditions are desperately bad or that the Fed is panicking and unable to fix the problem.

I think the problem is that banks and other owners of Collateralized Debt Obligations (CDOs) and other asset backed securities have not accounted yet for the true loss in value of these securities. Therefore corporations and others that deal with the banks don't know whether those institutions are solvent. The solution would be to write down the value of those assets and then recapitalize the banks to the extent of the write downs.

While the non-stop interest rate cuts do not solve what's ailing the credit markets, they also accelerate inflation. This causes businesses to hoard their money because they expect that it will be worth less in the future. In effect, the Fed is creating very high inflationary expectations which creates a very high hurdle rate for investments – and in a slowing economic climate, there are not many investments that can earn a high enough return to get green-lighted.

Some fairly simple math indicates that it wouldn't take much to wipe out the capital of the banks and hedge funds. And this simple math helps explain why the popular delusion that 'liquidity' = 'capital' is so dangerous. That mental equation works just as easily to create the illusion of prosperity as it does to eliminate the capital that is supposed to stand as bulwark against bad lending decisions.

That's because investment banks and hedge funds combined have borrowed $10.9 trillion on a sushi-thin slice of equity of $340 billion. Newsweek reports that on average, the ratio of borrowed money to underlying capital for investment banks and hedge funds is about 32-1. It reports that in 2006, investment banks had an estimated $280 billion in capital. At 32-1, the investment banks are borrowing $8.96 trillion. Meanwhile, hedge funds manage $1.9 trillion worth of assets – which would represent $60 billion in equity and $1.94 trillion worth of debt.

What would it take to gobble up that little piece of sushi? Well, collateralized debt obligations (CDO) represented a $6.1 trillion market. I say 'were' because I am guessing that this figure refers to the value of the CDOs when they were issued. And CDOs seem to be worth some amount below that now. I have seen estimates that they are worth 20 cents to 40 cents on the dollar of their original value.

But if investment banks and hedge funds had used all their money to buy these CDOs, then it would take a mere 6% decline in their value to wipe out that $340 billion in capital. Obviously investment banks and hedge funds have invested in other things besides CDOs. But when you borrow $32 for every dollar in capital, there's not much room for error.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

Nobody knows why the market rose 416 points yesterday. But The New York Times reports that the Fed made an extraordinary move yesterday -- it offered banks $200 billion for a month -- letting them use Collateralized Debt Obligations (CDOs) as collateral for the loan. This inflationary move helped drive oil to $109.72, up 357% since 1/19/01 and cut the dollar declined to one Euro to $1.5469, down 68% since 1/19/01.

But beyond the inflationary impact of the move, there's less here than meets the eye. Certainly, the surprise effect might have forced investors who had a short position to cover by buying back shares. That short-covering may have had a snowball effect. But there's also this -- if banks take those $200 billion off their books, there's still $6.1 trillion worth of CDOs on the market. And what will happen to those $200 billion worth of CDOs at the end of the month?

But there is an interesting twist -- the Fed claimed in a conference call with reporters that it was minimizing risk by accepting only securities that still had the highest triple-A ratings and that they would impose a discount, on mortgage bonds that appear to carry additional risk. If there is any meaning in those AAA ratings then the banks will end up pledging their highest quality securities as collateral and retaining more of the dodgy ones.

After all of the talk of splitting itself into two pieces, a "bad" part and a "good" part, Ambac (NYSE: ABK) will probably operate as only one company. The theory had been that the healthy muni-bond insurance operation should be separated from the business that insured more risky derivative instruments.

Breaking the company in half always had a number of complications, the worst of which is what would happen to common shareholders? Would they get shares in the "good" part of the business? Perhaps, but outside firms putting in money might want to keep that for themselves. Shares in the "bad" part of the business would probably be worthless.

Another issue is the legal troubles a split might cause. According to the FT, this raised the "possibility of lawsuits by banks and other groups that bought insurance on CDOs and other structured products."

Ambak is almost certainly going to have to live with its two businesses under that same roof. If the structured finance business continues to fall apart, the real question is how much more money will the insurance company have to raise.

Douglas A. McIntyre is an editor at 27wallst.com.

The good news is that MBIA (NYSE: MBI) saved its S&P "AAA" rating, meaning bonds it insures will not lose their value. A drop in the rating could have caused write-offs at banks that own paper covered by the bond insurer.

MBIA also announced yesterday that it will, sometime in the next five years, break its muni-bond insurance business from its structured finance operations, forming two companies. Structured finance bonds have lost much of their value because they include CDOs and mortgage securities.

The move may have helped save the company, but it comes with a huge cost. MBIA is eliminating its dividend to save $174 million a year. For investors taking advantage of the company's 10% yield, the news could hardly be worse.

MBIA may have bought itself some time, but it put the wood to shareholders to stay afloat.

Douglas A. McIntyre is an editor at 247wallst.com.

Amid calls for disclosure of more information on bidding for auction-rate bonds after dealers stopped buying the securities, two economists told BloggingStocks Friday that the problem of a lack of investor demand speaks directly to the need to re-capitalize bond insurers MBIA and Ambac.

"The problem is not merely a lack of demand for bonds. The problem is that institutional investors are shunning these investments because they are concerned about a lack of available insurance for this debt and related credit market uncertainty, which underscores the need to address the liquidity concerns of MBIA and Ambac," economist David H. Wang said Friday.

MBIA, Ambac: two linchpins

The bond insurers, Wang said, are two linchpins of the bond market [municipal, corporate], and, by extension, of the financial markets.

Shares of MBIA (NYSE: MBI) and Ambac (NYSE: ABK) have lost more than 70% of their value in the past six months, as investors have fled them amid concern that the two do not have sufficient capital to fund insurance policies for mortgage-backed and collateralized debt obligations held by banks and institutions. MBIA and Ambac executives have rejected the accusations, arguing that they have sufficient capital to fund claims and can modify/improve their business models, long-term, aided by re-capitalization. MBIA fell 80 cents to $11.82 and Ambac fell 45 cents to $10.08 in Friday afternoon trading.

It seems as though every week, the public is forced to learn another one of Wall Street's strange names for a surefire deal that couldn't miss. But the reason we're learning about those strange names is because -- contrary to promises -- the can't miss deals are shutting down -- taking Wall Street's credibility down along with them.

The latest of these is auction rate securities (ARSs) -- a $330 billion market for long-term bonds that are supposed to pay lower rates because their interest rates are set through auctions. The New York Times reports that municipalities who issued ARSs are suffering because 1,000 of these auctions failed and instead of paying 3% interest rates, they have to pay 20%. And if that wasn't bad enough, the investment banks that oversee these auctions are refusing to let investors withdraw their money.

Which investment banks are imposing this pain? Goldman Sachs Group (NYSE: GS), Merrill Lynch (NYSE: MER), and Lehman Brothers Holdings (NYSE: LEH) and the problem with ARSs is not limited to municipalities entities such as the Port Authority of New York and New Jersey. Closed-end mutual funds, student loan companies and corporations also issue them.

Moody's (NYSE: MCO) is thinking of releasing a new ratings system that does not use letters, but has numeric ratings and "warning labels" for securities that may be difficult to analyze.

According to The Wall Street Journal, "one of the most significant changes being considered by the parent of Moody's Investors Service: a new, 21-point numerical scale to rate structured securities." The new system would also help investors look at CDOs and other risky investments differently from corporate bonds.

The whole exercise is bogus. Moody's could have employed a similar system long ago. Why are numbered ratings any different from those that use letters? Why didn't the firm have a systems that indicated the risks in complex securities such as CDOs and other structured investments?

The Moody's move is simply an attempt to try to hide and rectify the substantial flaws in the system that exists now. And, it is a feeble attempt to boot.

Douglas A. McIntyre is an editor at 247wallst.com.

Massachusetts Secretary of State William Galvin is suing Merrill Lynch (NYSE: MER), accusing the firm of defrauding the city of Springfield, home of Homer Simpson, with subprime investments.

Merrill Lynch has already taken the unusual step of agreeing to buy back $13.9 million in subprime debt from the municipality at its original value after deciding that brokers had not been authorized by the city to buy the debt in the first place.

Merrill says it's puzzled by the suit, but Massachusetts is arguing that it told Merill to invest in "instruments that yielded more than Merrill's money market account as long as the products were triple-A rated by the major credit-rating agencies." It says that Merrill didn't warn Springfield about the risks of the CDOs.

Springfield officials -- and the secretary of state -- should take a look at the chart above. The idea that they could earn above-average returns with no risk defies the most basic principles of investing.

Maybe the lawsuit does have merit -- I have no idea. It appears that Springfield may have been misled about what it was getting itself into. But the fact is, Merrill lost big on subprime too because everyone forgot about the handy-dandy chart above: if it sounds too good to be true ...

Merrill Lynch (NYSE:MER) will buy back almost $14 million in collateralized debt obligations which it sold to Springfield, MA. Because of the subprime mess, those instruments have lost over 90% of their value. The city said that Merrill should have disclosed more about the financial product.

In a bit of a PR compromise, Merrill and the city has decided the bank will do the right thing. "The City of Springfield and the Springfield Financial Control Board have said that neither body approved the purchases of these investments," said Mark Herr, a Merrill spokesman according to The Wall Street Journal.

There would seem to be some window dressing on that. Since when is Merrill responsible for the approval of purchases of its own products? Someone in Springfield's government obviously approved the buy, but state authorities are probing whether Merrill disclosed the risks of the CDOs.

Merrill is setting a bad precedent. What happens when other cities and states say they were mislead. Does Merrill give all of them a refund?

Douglas A. McIntyre is an editor at 247wallst.com.

Add the FBI to the growing list of law enforcement officials probing the subprime mortgage scandal.

The New York Times is reporting that the agency is "looking into possible accounting fraud, insider trading or other violations in connection with loans made to borrowers with weak, or subprime, credit." The FBI wouldn't disclose to The Times the names of any of the companies involved but it shouldn't be that hard to guess.

New York Attorney General Andrew Cuomo and attorneys general from in Ohio, Massachusetts, Illinois and Connecticut are also investigating the industry as is the Securities & Exchange Commission. Mortgage fraud is a serious and growing problem that deserves the attention.

You can bet that in an election year some huge settlements and perhaps even indictments are in the works. The Gucci-loafer wearing Wall Street bankers who made millions selling CDOs are no doubt ringing up their lawyers as we speak.

It couldn't happen to a nicer bunch of people.

Bloomberg News reports that the Federal Reserve Bank's 75 basis point emergency rate cut this morning has not damped fears in the market. The Fed said this along with its cut: "While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate. The Federal Open Market Committee took the action in view of a weakening of the economic outlook and increasing downside risks to growth."

And yet, U.S. futures markets seem to have recovered somewhat from where they were before the announcement. For example, the S&P 500 Index futures expiring in March retreated 40.5, or 3.1%, to 1,284.8 as of 8:36 a.m. in New York after earlier slumping as much as 5.3%. And The Dow Jones Stoxx 600 Index added 1.5% after earlier dropping as much as 4.1%.

I think the problem is that investors holding mortgage-related securities such as Collateralized Debt Obligations (CDOs) need to mark them to market and raise capital. Cutting interest rates 75 basis points lowers the value of the dollar and contributes to higher oil prices, but it's not clear how it helps CDO investors raise capital.

If the only tool you have is a hammer, every problem looks like a nail.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.