Tangled hairball. House of cards. Call it what you will, it was spit out or stacked up by the shamans on Wall Street, who used this financial voodoo to earn huge fees from underwriting these securities.

That’s how the $1.5 billion Norma CDO came about.

A key to the Journal story’s success is that it scored an interview with Corey Ribotsky, the Long Island-based penny-stock broker, whom Merrill set up as a “CDO manager” to recruit investors and administer Norma. Ribotsky hooked up with Merrill at a Long Island club after meeting a criminal defense lawyer who introduced him to a Merrill bond salesman.

Why was Merrill Lynch essentially setting up businesses for such outside CDO managers—and why Ribotsky, who’s being sued by three separate companies for manipulating their stocks? The Journal doesn’t answer this directly, and there may be another story there.
Still, his quotes are priceless:

“It sounded interesting and that’s how we ventured into it,” Mr. Ribotksy says.

Well, there you go.

The Journal reveals that Norma was comprised of derivatives and securities that Merrill itself had underwritten:

Such cross-selling benefited banks, because it helped support the flow of new CDOs and underwriting fees. In fact, the bulk of the middle-rated pieces of CDOs underwritten by Merrill were purchased by other CDOs that the investment bank arranged, according to people familiar with the matter. Each CDO sold some of its riskier slices to the next CDO, which then sold its own slices to the next deal, and so on.

That circular cross-selling also multiplied the impact of housing defaults. The Journal cites a UBS study saying banks sold CDOs made up of derivatives worth three times more than the value of the underlying, asset-backed securities.

The banks are getting stuck with billion of dollars in losses in large part because they kept the “safest” parts of the CDOs on their books, since their low yields attracted few buyers. Since they concentrated CDOs in areas that have been slammed—like BBB-rated subprime securities—their values have taken huge hits. The Journal says mezzanine CDOs could account for up to three-quarters of the losses of the biggest banks like Citigroup and Merrill.

While the best mortgage-crisis stories may be yet to come, this one certainly helps untangle that hairball a bit.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu.