Tuesday, July 29, 2008

Facing Reality Can Be Good

Turning around a poor financial situation sometimes requires facing the brutal truth. Merrill Lynch did that yesterday when it sold off $30.6 billion of CDOs for $6.7 billion, for $0.22 on the dollar.

Many financial institutions continue to hold their CDOs at 70% of face value, hoping that a recovery in financial markets will restore their value. Unfortunately, the carrying institutions need to periodically value the CDOs to market, which has resulted in continuing writedowns each quarter. Merrill's action, while very painful, gets rid of the burden of illiquid debt and allows Merrill to proceed unencumbered by the CDO cloud.

While I don't know if this signals a bottom for financial stocks, I believe it may indicate the bottom for Merrill. I decided to buy 100 shares of Merrill Lynch (MER) for $24.99 in my trading account. If Merrill should rally as other financial institutions take Merrill's approach, I will look to sell the position in the mid thirties.

Disclosure: At time of publication, I own Merrill Lynch in my trading account.

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This is not financial or investment advice. Please consult a professional advisor.

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