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.

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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. Follow him on Twitter at @ryanchittum.