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Hard-to-Price Paper Hampers Banks

Wall Street firms holding unloved mortgage-related debt wonder: hold on, or sell cheap?

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


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Merrill Lynch


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

that they are seeing blocks of unusually large sizes being liquidated by motivated sellers of mortgage-tainted paper. One trader tells

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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


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, are taking the latter option, even though bids for esoteric mortgage debt are either nonexistent or at steep discounts to their original price.

According to traders, there has been a number of forced liquidations of CDO pools, with a notable deal unspooling over the past three or four days.

Traders declined to provide precise details of the sales, including sizes. But one observer said that asset-backed CDO paper was believed to be tied to an offering from firm Tricadia Capital in New York. Tricadia was founded in 2003 by Arif Inayat and Michael Barnes, who both previously worked for


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. A call to Barnes was not returned.

UBS is believed to own super senior tranches of debt associated with Tricadia's CDO, and was compelled to sell its holdings for prices equivalent to between 13 cents and 19 cents on the dollar, according to one deal tracker. Such a move for UBS would mean that it faces some additional writedowns when it reports its fourth-quarter earnings in mid-February.

A UBS spokeswoman in New York declined to comment.

According to its third-quarter reports, UBS's largest mortgage positions are in super-senior portions of asset-backed securities, or ABS, CDOs, where the net exposure is $20.2 billion. It also has super-senior tranches of mezzanine ABS CDOs, which account for $13.2 billion and $16.8 billion of net exposure to residential mortgage-backed securities. In December, the Swiss bank wrote down $10 billion in connection with its mortgage holdings.

"The fact is, the market still blows," notes one trader, who declined to be identified. "People are still talking about taking big writedowns."

Shedding assets at deeply discounted prices has the additional effect of forcing other firms to further ratchet down the values of their own credit portfolios.

Adding to bank woes are fears that a possible recession may further erode confidence in the performance of financials. On Thursday,

Federal Reserve

Chairman Ben Bernanke, acknowledging that the market is in worse shape than the Fed had previously believed,

strongly indicated the Fed would slash rates to stave off housing and credit problems.

Next week, Citi, Merrill,

JPMorgan Chase

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Wells Fargo

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Washington Mutual

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, will try to offer a clearer picture of how badly writedowns have shaken up their businesses.