They’re Just Like Us!

One of my favorite indulgences is to pick up a copy of US Weekly and read the segment called “They’re Just Like Us!” In it, paparazzi snap celebrities doing ordinary things—look, there’s Meg Ryan eating lunch; Madonna running in Central Park; and Drew Barrymore grocery shopping. I thought of the feature after reading two articles about Merrill Lynch: one in the April 16th edition of the Wall Street Journal (Merrill Upped Ante as Boom In Mortgage Bonds Fizzled by Susan Pulliam, Serena Ng and Randall Smith) and the other about Merrill’s former CEO, Stan O’Neal in the March 31, 2008 edition of The New Yorker (by John Cassidy).

The New Yorker article took an in-depth look at O’Neal, but what made me think “they’re just like us” is the description of how an obviously smart guy could be seduced by the outsized returns of a complicated asset—in this case it was collateralized debt obligations. I can not count the number of times that people come in and talk to us about opaque strategies or products that they don’t really understand. “I really don’t know what it is, but I made money.” If that happens, my advice is to get out while the getting is good!

In the Journal article, it is noted that Merrill made easy money early in the housing boom. Again, “they’re just like us!” If you bought technology stocks in the mid-nineties or participated in IPOs (which you never really understood), you probably made a bunch of money. But as a good idea matures and ultimately morphs into a boom or mania, things can get dicier. The risk ratchets even higher and you may think to yourself, “I’ll be all right—I’ll know when to get out.”

That’s kind of what happened at Merrill. According to the Journal, “By early 2007, as cracks in the housing and mortgage markets widened, Merrill again missed a chance to scale back. In fact, it 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…Instead of scaling back its underwriting of CDOs, however, Merrill put the business in overdrive. It began holding on its own books large chunks of the highest-rated parts of CDOs whose risk it couldn't offload.”

They really are like us-tempted by big returns, investors as big as Merrill and as small as you, can get sloppy and disregard risks that exist. The behavior usually does not change until the market extracts its pound of flesh for these mistakes. In Merrill’s case, we’ll find out whether the bleeding has stopped when it reports its quarterly results today.