The Big Bath and other familiar Wall Street themes

In their wide-spread perfection of off-book accounting fraud, US financials are making ENRON executives look like a haggle of harmless school kids. Yesterday Citigroup became the next big player to announce a “shocking” reversal of fortune quantifying the leading edge of their loan loss write-downs at 11 billion for the third quarter.
Citigroup's Charles “Chuck” Prince became the next in a growing line of CEO's to step down in the wake of the unfolding sub-prime crisis. The debt-market turmoil of the past few months, has taken a tremendous toll. Citigroup's stock is down 31% this year and almost 9% in the last week. People familiar with the matter said the Securities and Exchange Commission is looking into the bank's accounting for its off-balance sheet investment funds that have recently attracted scrutiny.
The bloodbath in credit and financial markets will continue and sharply worsen: “The amount of losses that financial institutions have already recognized – $20 billion – is just the very tip of the iceberg of much larger losses that will end up in the hundreds of billions of dollars. At stake – in subprime alone – is about a trillion of sub-prime related RMBS and hundreds of billions of mortgage related CDOs. But calling this crisis a sub-prime meltdown is ludicrous as by now the contagion has seriously spread to near prime and prime mortgages. And it is spreading to subprime and near prime credit cards and auto loans where deliquencies are rising and will sharply rise further in the year ahead. And it is spreading to every corner of the securitized financial system that is either frozen or on the way to freeze: CDOs issuance is near dead; the LBO market – and the related leveraged loans market – is piling deals that have been postponed, restructured or cancelled; the liquidity squeeze in the interbank market – especially at the one month to three months maturities – is continuing; the losses that banks and investment banks will experience in the next few quarters will erode their Tier 1 capital ratio; the ABCP and related SIV sectors are near dead and unraveling; and since the Super-conduit will flop the only options are those of bringing those SIV assets on balance sheet (with significant capital and liquidity effects) or sell them at a large loss; similar problems and crunches are emerging in the CLO, CMO and CMBS markets; junk bonds spreads are widening and corporate default rates will soon start to rise. Every corner of the securitization world is now under severe stress, including so called highly rated and “safe” (AAA and AA) securities.
The reality is that most financial institutions – banks, commercial banks, pension funds, hedge funds – have barely started to recognize the lower “fair value” of their impaired securities. Valuation of illiquid assets is a most complex issue; but starting with the November 15th adoption of FASB 157 the leeway that financial institutions have used so far for creative accounting will be much more limited.”
Remember the key to the big bath theme on Wall Street is to call out the current management, make a big show of casting them out, the SEC investigates and the company uses the occassion to purge their bad financial news in one full swoop. We look for more news on this theme in the weeks ahead.

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