Forum Post: 'A Million In Bonus For A Billion In Toxic Assets': How a Handful of Merrill Lynch Bankers Blew Up Their Own Firm

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'A Million In Bonus For A Billion In Toxic Assets': How a Handful of Merrill Lynch Bankers Blew Up Their Own Firm

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How a Handful of Merrill Lynch Bankers Blew Up Their Own Firm

Two years before the financial crisis hit, Merrill Lynch confronted a serious problem. No one, not even the bank's own traders, wanted to buy the supposedly safe portions of the mortgage-backed securities Merrill was creating.

Bank executives came up with a fix that had short-term benefits and long-term consequences. They formed a new group within Merrill, which took on the bank's money-losing securities. But how to get the group to accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge of the arrangement.

The executives said this group, which earned millions in bonuses, played a crucial role in keeping the money machine moving long after it should have ground to a halt.

"It was uneconomic for the traders" -- that is, buyers at Merrill -- "to take these things," says one former Merrill executive with knowledge of how it worked.

Within Merrill Lynch, some traders called it a "million for a billion" -- meaning a million dollars in bonus money for every billion taken on in Merrill mortgage securities. Others referred to it as "the subsidy." One former executive called it bribery. The group was being compensated for how much it took, not whether it made money.

The group, created in 2006, accepted tens of billions of dollars of Merrill's Triple A-rated mortgage-backed assets, with disastrous results. The value of the securities fell to pennies on the dollar and helped to sink the iconic firm. Merrill was sold to Bank of America, which was in turn bailed out by taxpayers.

What became of the bankers who created this arrangement and the traders who took the now-toxic assets? They walked away with millions. Some still hold senior positions at prominent financial firms.

Washington is now grappling with new rules about how to limit Wall Street bonuses in order to better align bankers' behavior with the long-term health of their bank. Merrill's arrangement, known only to a small number of executives at the firm, shows just how damaging the misaligned incentives could be.

ProPublica has published a series of articles throughout the year about how Wall Street kept the money machine spinning. http://www.propublica.org/series/the-wall-street-money-machine ...Our examination has shown that as banks faced diminishing demand for every part of the complex securities known as collateralized debt obligations, or CDOs, Merrill and other firms found ways to circumvent the market's clear signals. http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis

The mortgage securities business was supposed to have a firewall against this sort of conflict of interest.

Banks like Merrill bought pools of mortgages and bundled them into securities, eventually making them into CDOs. Merrill paid upfront for the mortgages, but this outlay was quickly repaid as the bank made the securities and sold them to investors. The bankers doing these deals had a saying: We're in the moving business, not the storage business.

Executives producing the securities were not allowed to buy much of their own product; their pay was calculated by the revenues they generated. For this reason, decisions to hold a Merrill-created security for the long term were made by independent traders who determined, in essence, that the Merrill product was as good or better than what was available in the market.

By creating more CDOs, banks prolonged the boom. Ultimately the global banking system was saddled with hundreds of billions of dollars worth of toxic assets, triggering the 2008 implosion and throwing millions of people out of work and sending the global economy into a tailspin from which it has not yet recovered.

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