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Monday, November 8, 2010

Citi Bonds v Merrill Lynch Notes

Citi Bonds v Merrill Lynch Notes
I was not so shocked to find the headline “Citi Debt Funds Probed By SEC” on the front page of the Wall Street Journal this morning. The story outlines how Citi Group, through its minions at Smith Barney, was selling proprietary products designed to mimic a bond index. The products were allegedly being sold as having the same risk profile as the index, which was false. 
When the financial system’s liquidity evaporated, the true nature of the instruments was reflected in a 71% loss of value. Turns out these bond replacements had used debt to enhance returns. Citi stepped in to swallowed enough of the loss to only put investors out 61%. The difference might be an indication of how much money was being scrapped off the top by Citi Group when they were sold. That’s just my guess.
When is the SEC going to get around to looking at the Merrill Lynch practices I outline in my book “Secrets of the Skim”? Merrill was doing the same thing with their structured products. Enticing clients to move large cap allocations into proprietary instruments that used debt and derivatives to track an index (the S&P 500 was a favorite), Merrill Lynch misrepresented the risk associated with the investment just like Citi Group. Does the SEC think that Citi was the only player in this game? 
Since the Merrill Lynch products were debt instruments on paper from such illustrious firms as Bear Stearns, Lehman Brothers, and AIG, their risk profiles were drastically different from a basket of large cap stocks. The use of debt to enhance returns also skewed the risk/return curve.
If the SEC is concerned about the bond vipers at Citi they should also be concern about the structured product masters at Merrill Lynch. 

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