Prof. Sedacca,

Interesting article indeed, but I don't believe all level 3 assets are created equal. L3 assets that are real estate based (directly or indirectly) have greater vulnerability to declines in their unobservable value. The question becomes what would force one of companies 2-10 to have to observe (by selling) their assets and thereby be driven into Bear Stearns territory?

Also, given the recent interesting events surrounding BSC, I wouldn't touch a credit default swap for one of these companies with a 10 foot pole. Just because they go bankrupt doesn't mean that they will ever default on their debt; not in our brave new world.

What happens if an "observable input" results from one of these companies liquidating a hard to price/sell asset, (eg. forced due to one of the monlines losing their AAA rating status & thus eliminating the AAA rating on some of these assets) that is the same or similar enough to assets that the other companies have in their Level 3 pool)?

I have read where some assets are being classified as Level 3 even though there may be a discernible market & price available - just not the price level these companies are prepared to sell at (since they would then have to recognize sizeable reductions in values of similar Level 3 assets to the point where they would be insolvent (under mark to market accounting for example) and realize a double whammy - remove a sizeable amount of assets from Level 3 and recognize losses in the process that would further erode their capital reserves).

if these massive Level 3 asset pools of these financial companies are inflated as they appear to be, how can the Fed possibly prop them up like they did with BSC, should another one or two start to implode under the weight of these overinflated asset values?

I understand why they would want to avoid recognizing losses in these assets at all costs (even to the point where auditors are in on the "fix"), but what is holding us back from being on the precipice of a massive failure of the entire US financial system (and perhaps far worse, the social chaos that might ensue?)

this looks to me like scary, cataclysmic type stuff...can someone point out where I am overreacting?

Bennet,
Are these estimates of level3 assets, face value against tangible equity? Any sense of how much have been marked down already....according to anecdotal evidence these assets should be down minimum 5-10% and more likey 20-40%...which if you include level2 mark downs, would leave (at least the top 5-6 players) insolvent??
Where are the auditors and how can the auditors not qualify their opinions under these circumstances??? More questions than answers, but maybe you can tackle some of them.
minyan peter

Surprised to see NWA make this list, unlike insurance companies. What are their level II holdings comprised of? Toxic or non?

Put it this way. A 60 billion dollar bid list from a SIV in enforcement mode didn't trade. If it had traded, the SIV would have been left with negative equity...

Please explain NWA being on the list. Thank you.

Does anyone ever discount C's shareholder equity by the intangible assets?

Minyan Matt

below are comments from a friend of mine who works in the finance sector. i find it an interesting counter point to the general trend of views on minyanville. i tend to believe that this on-going credit issue is not so simple as a "mild-recession"... but my tendency towards pessimism is given a pause from the cogent comments i pasted in below. comments?

--tim


since i have an in-house mortgage-backed and asset-backed analytics department that does indeed price these illiquid securities, i'll comment here that while this is very good information from a high level, 50-foot flyover for the average day-trader, this is a fabulous example of where statistics can be abused if isolated and not put into proper context -- something i learned best from Edward Tufte.

True one statistic of % of assets held in illiquid securities is a good cautionary red flag -- but one needs to also then examine the breadth of the in-house analytics group employed used to price such securities: the average (not total or group total) years of experience the team has with the asset class type, the sophistication of the tools made available to them for pricing and how conservative a stance they take as a part of their pricing methodology used to value the securities. Normally these parameters are a little hard to drill down to which is why a flat % may be a good surface gauge. But MBS and ABS team exposure usually *is* public information if you look on the right websites. Coupled with company experience with such asset classes, you can gauge whether it's a good bet or not. And MBS & ABS are fabulous hedging and diversification vehicles to any portfolio and usually reap great rewards when used appropriately by experienced teams. my company avoided much of the sub-prime debacle because we 1) priced conservatively when in doubt and 2) have a team with a long track record of both working together and working with this particular class and 3) have an in-house built pricing model that challenges any on the market.

This is interesting because i find these website articles usually use headline grabbing statistics that often lack some very important factors, and being the stats nut that i am, i tend to zone in on the error of sampling, population or mere empiracle testing and argue that while they may be "statistically" correct, Edward Tufte has taught me to demand that they defend the story they are trying to portray with that set of stats. For example, an article came out last week from Boston - yes, Boston! that showed the distribution of single men versus single women mapped across the US. The surplus was mapped in different sizes of bubbles -- blue for men, red for women, the sized based on the size of the surplus. And then this was followed by hypothesis about what such figures implicate. They pointed out very quickly in the article that Los Angelas, Seattle, Atlanta and Florida had very high surplus concentrations of single men. and as I read this i was immediately struck with the thought (which came immediately from very logical and educated experience) YES! because they are more GgAY!!! I mean if a young single woman from another country moved here, picked up this article and decided to base their relocation decision based on this article, they'd be *sorely* disappointed, not to mention frustrated.

Hello, this is Bennet. I have only one question. If someone put water pistol to head and said SELL, what would happen? The answer is I don't know and none of us likely want to know. I operate in a defined risk environment. There is a trend towards hard to price, and then impossible to sell securities. In fact, I recently saw a 60 B bid list of these type of securities of a SIV in enforcement mode NOT TRADE. Why? Because if they had traded at the bid the SIV would have been below 0. So even if the securities are supposedly 'worth more' they are worth what someone is willing to pay. THAT is the problem. Cheers, Bennet.

hi bennett -- thanks for the reply but i don't think you really answered her points. granted some of these bizarre instruments (of death?) are, in the end, priced by the highest bidder, if there is one. it is the forecasting of those bids were the hocus-pocus comes into play. should we just hire the weather channel for some nebulous prognostication? are you saying that there is NO connection between analysis and the actual auction results right now? minyan tim

The actual answer is 'I don't know'. I use that a lot these days! All I DO KNOW is that what I own for every client (wealthy individual, institutional, our fund or my own account), I could sel in30 seconds. I was taugh a long time ago about the 'New York Times Test'-never buy anything you wouldn't put on the front page of the New York Times....I doubt the Level 3 assets would pass the test. I guess that's my point. Cheers, Bennet.

You are NOT over reacting. You are speaking the sad truth. Just wait until they are downgraded and those that have 'downgrade provisions' i.e insurance companies HAVE to sell. That's the next leg. Oops, I gave up some of my next commentary! bennet.

I would ask your friend this. Try putting them out on a bid list and see what happens. Trade them and then tell me what the book value of the company is. After all, markets are only the intersection of a bid and an offer. Models mean nothing to me and anyone that uses models to manage money is a fool. They break. All the time. Bennet

Nope. But they should.

They don't disclose, but again, if they could sell them, or mark them, they would. If I had to guess , some oddball hedge against fuel or oil that went awry. Bennet.

The auditors aren't qualifies to price them. But either is anyone. That's the problem. In November, long before the last wave of mortgage delinquencies, Citi's CFO said they were marking 65B in CDO's 'to a reasonable stab' Nice. Bennet.

It ALL matters. If they could sell em, mark em, whatever, they would. Period. Bennet.

my friend responds to your response, her comments below:

----

here's another issue I have since this gentlemen raised the difference between indiviual and institutional clients - (good point by the way) - i talked to a friend of mine who works for one of the companies on the list and he verified the asset %, but also pointed out that the % was stated in terms of *parent company* assets which takes into account very many divisions of the firm worldwide -- some of which operate quite autonomously from the others with quite different mix of AUM. He then further pointed that his particular division which operates differently and holds its own AUM breakout (eventually rolled up to the parent AUM) has only marginal illiquid assets and it hurts his division if people base their institutional investment decision on the overall flat figure. He manages institutional assets which cannot be invested by mere individuals but rather other companies as part of their defined benefits program.

Something similar happened not too long ago when companies were getting in trouble for market timing and the SEC cracked the big whip. Many of these companies sold off that business unit involved or shut down entire operations! The bad publicity hurt the whole company even if other business units never once engaged in market timing in the entire existence of the firm! That is *not* to say those engaged in market timing should be left unscathed. It just loops back to my point that very high level broad statistics *ought* to be caveated at the very least so as not to cause undue harm: footnote, footnote, footnote!!! such as: "% based on entire parent company AUM not individual investment centers, some investment divsions may hold 0% illiquid assets" etc. If you open a Consumer Reports Magazine and look at their rankings on various products, there's usually a decent sized paragraph, albeit in very fine print, that specifies the criteria for analysis or comparison -- that is to protect themselves from someone abusing the information and holding them liable for misleading data.

Now possibly I missed the part in that article that specified the criteria for the stats, but I do recall it wasn't evident throughout the text. I stand corrected if it were.

But still, I do not disagree with the responder, some very good points indeed.

Restatement: If it's L3, it's illiquid. But some illiquid assets will eventually develop a market as fear eases. Other illiquid assets will never again have a market because they are precisely the sort of security which investors fear. Which sort of illiquid asset a firm owns will be very important as the process unfolds. So, if NWA owns some odd hedge against oil prices increasing they are perhaps actually doing very well with their L3 assets; if MER owns a whole lot of Alt-A mortgage tranches they are sooner or later going to wind up being taken over by someone less foolish. Or bailed out at taxpayer expense - depending on whether their campaign contributions went to the right places, I guess.

Dean - "if MER owns a whole lot of Alt-A mortgage tranches they are sooner or later going to wind up being taken over by someone less foolish. Or bailed out at taxpayer expense - depending on whether their campaign contributions went to the right places, I guess."

In light of recent events you were quite prescient.

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