After Merrill's Sale of Bad Debt, Few Have Followed

The securities Merrill sold to Lone Star for $6.7 billion had been valued a month earlier on Merrill's balance sheet at $11.1 billion, a figure that already reflected big write-downs. In conjunction with the sale, Merrill also announced a separate set of write-downs and said it would sell $8.5 billion of stock to pad its balance sheet.

By holding on to their CDOs, other firms might be able to avoid booking such sharp losses -- and raising fresh capital needed to offset them. The companies also could continue to bank the cash flows generated by the CDOs, similar to collecting interest on a loan, until the securities mature and roll off the balance sheet.

But in the meantime, the firms are risking that the housing market will continue to deteriorate. This could bump up the default rates on the CDOs and require additional write-downs on the assets. The troubled securities would also continue to taint the balance sheets of Wall Street firms, contributing to a psychological overhang among investors that could postpone any market recovery.

Analysts said that Merrill chief executive John Thain, hired in December, was in a unique position to dump the CDOs in essentially a fire sale. Bad bets on the securities were made on the watch of his predecessor, Stan O'Neal, allowing Thain to skirt the blame for the loss. And Merrill's balance sheet was strong enough to absorb the impact of the sale.

The assets Merrill sold to Lone Star were called "super senior," meaning they were supposed to be the safest type of CDOs. But Merrill's risk calculations for these securities had proved to be way off.

Merrill still has about $8.8 billion of exposure to these super-senior CDOs. The company says most of this is tied to mortgages from 2005 and earlier and thus even safer because, analysts say, mortgage-lending standards were tighter back then.

Other firms were burned by CDOs, including J.P. Morgan Chase, Bank of America and Morgan Stanley. The latter had ironically bought the securities to hedge a correct bet that the subprime market would weaken. The ill-fated hedge accounted for the bulk of the $7.8 billion write-down that Morgan Stanley took in last year's fourth quarter for its subprime trading division.

Citigroup is the most exposed to super-senior CDOs, according to Jeff Arricale, manager of the T. Rowe Price Financial Services Fund in Baltimore. The bank had an exposure of $18.1 billion as of June 30 after accounting for hedges.

A Citigroup spokesman said the bank is still on track to shed $400 billion of assets over the next three years, as chief executive Vikram Pandit promised investors in May. Some of the reduction is expected to come from asset sales, and some from the assets themselves reaching their maturity date and rolling off the balance sheet.

"I suspect there would be a little bit of a sigh of relief in the market" if Citigroup unloaded its super-senior CDO assets, said Arricale. "But I don't think they have to do something that would require them to raise capital right away like Merrill Lynch had to do. They have the flexibility to hold on or find a buyer at a more appropriate price."

But for now, the only relevant price is the one that buyers are willing to pay.

In keeping with the famously tight-lipped style of hedge funds and private-equity firms, none of the potential buyers identified by analysts -- including Fortress Investment Group, BlackRock, Blackstone Group and KKR -- would comment on their strategies for approaching the CDO market.