Hard-to-Price Paper Hampers Banks

The difficulty in pricing esoteric securities packaging mortgage debt in a struggling credit market remains a significant threat to battered Wall Street firms, many of which are set to report earnings next week.

Big firms such as Citigroup(C Quote - Cramer on C - Stock Picks) and Merrill Lynch (MER Quote - Cramer on MER - Stock Picks) are expected to take writedowns on such structured products totaling as much as $25 billion and could face further carnage within their already unsettled balance sheets. According to a report in the Wall Street Journal on Thursday, the firms are turning to Middle East and Asian investors.

But even in the face of the best efforts by Citi, Merrill and other financial firms to shore up their balance sheets, the markets do not appear to be cooperating.

Debt traders focused on esoteric collateralized debt obligations, or CDOs, tell TheStreet.com that they are seeing blocks of unusually large sizes being liquidated by motivated sellers of mortgage-tainted paper. One trader tells TheStreet.com that forced sales have occurred in the early part of the year because some CDO managers are experiencing technical defaults and are having trouble making interest payments on the so-called super senior tranches of CDO debt that has been sliced and tiered based on credit ratings.

Such defaults are leaving holders of CDO paper with a difficult decision: continue to hold onto the underlying securities of these CDOs even as prices are falling off a cliff, or opt to unload for pennies on the dollar? Some investors, including troubled big banks and monoline insurers, like MBIA(MBI Quote - Cramer on MBI - Stock Picks) and Ambac(ABK Quote - Cramer on ABK - Stock Picks), are taking the latter option, even though bids for esoteric mortgage debt are either nonexistent or at steep discounts to their original price.

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