A Few Quick Musings...

Merrill effort to "lance the boil" shouldn't be surprising. If they survive, and they will, the question is in what form, this will be seen as the bottom for Merrill re: this crisis. As any good trader does when a position is foisted upon him/her, the position is evaluated and quickly as possible, dumped. Perhaps if Mr. Thain inherited the CDO position at 22, he might have been more inclined to keep it. Perhaps not. As the new guy in town, Mr. Thain has had a free shot to do whatever he wants, but that window only stays open for so long. Merrill isn't Goldman Sachs and if he didn't know it before, he knows it now. They shouldn't try to be, either. Fortunately for Merrill and Thain, the company has a lot of assets it has accumulated over the years that it can offload to others. Even at depressed prices, these assets are at much higher levels than what Merrill paid for them; look at its stake in Bloomberg for example. When the CDO position increases in value over time, and it will because Lone Star isn't paying $6.7 billion looking for a tax writeoff, Thain can either say: 1) Oops, I made a mistake. Here is my resignation.; 2) We are taking Merrill in a new direction and CDOs are no longer part of our core business. It was necessary to get them off the books so that we can focus on returning to our roots. I think choice 2 is more likely, of course, as it is what Merrill does best.

Next up is the Treasury weighing in on speculation in the commodity markets. Their verdict, along with a raft of other so-called experts, is that speculation is non-factor in the run up in commodity prices. It is hard to believe, to say the least. The value of every commodity, save potatoes and wine (good news for me on both counts) has shot skyward. This, according to the aforementioned raft, is solely due to supply and demand factors. Now I sat through all the microeconomics courses and understand that the cost at the margin determines the price at the physical commodity (otherwise, oil would be $10/barrel as it costs the Saudis $2 to pump it out of the ground), but there is more going on here than the physical commodity market. I agree completely that it is supply and demand driving prices, but it is the supply of futures contracts, not commodities, that is the problem.

The pundit world says that the futures market in its present form is necessary for hedging , price discovery, speculation, etc. Up to a point that is true. However, when the futures market usurps the cash market as the primary driver of value, then it has gone too far and changes need to be made (The same could be said about the fixed income market, where derivatives have dwarfed the cash market, exacerbating the problem there). Not to sound paranoid, but it is in the best interests of the participants to perpetuate this fantasy regarding prices. The reason is that everybody wins and losers are the non-professionals and commodity consumers (most people in the world). The thought is that there is an open ended supply of futures, so prices will be constrained by the physical commodity level. The problem occurs when a bunch of new participants get involved, funds, hedge funds, ETFs, etc., that have no stake in the physical commodity price. Right now, money has been pouring into this space at a torrid pace, causing a one-way movement. Couple that with easing of market entry and low margin requirements and you are left with situation that currently exists in that market. Changes, especially in relation to margin requirements, need to be made.