From Bedford Falls to Potterville

Round two of the credit crunch crisis will start on Thursday when we start to find out just how bad off the investment banking industry is as it prepares to repair a major chink in its armor by standardizing valuations for Level 3 assets.

There may be a lot of CEOs canned and investigations and lawsuits from irate investors in the offing, and maybe a surprisingly big rate cut by Bernanke to lessen the sting, but this one promises to get really, really ugly.

Many Level 3 assets are mortgage-related, but also include credit card debt and other unsecured loans. As these are virtually untradeable assets and as property values plummet, expect to see huge write-downs and a very shaky stock market as all this gets sorted out.

....starting Nov. 15, fair value [of a Level 3 asset] at any given moment is the price you can sell the thing for, period. So now all the banks and dealers have to disclose how much of what's on their books is crap that there's no bid for, and write down the value to what it's really worth, which, in some cases, may be bupkes. Needless to say, the previous valuations of those investments, using management's presumptuous assumptions, were much closer to par than the new ones will be."

"Yow. That could get downright ugly. I mean, ABCP and SIVs are already on life support, and that new MLEC fund they're talking about to buy the SIV assets is dumb - solving a debt problem with more debt, yeah, like that'll work - and the markets for CDOs, CMOs, RMBS and CLOs are all similarly distressed, so either the banks and investment banks have to take the crap onto their own books and take big writedowns or sell it at a huge loss. Either way, it could be real nasty."

This doesn't mean the shit is going to hit the fan for the markets on Thursday. First, some banks may find some of these assets to be worth more than their in-house estimations, while others will report that these assets are severely inflated. Going forward, every time the accountants crack the books and every time there's a corporate report, all asset valuations will have to be based on some realistic measures.

Goldman Sachs has already taken a lot of criticism for what is deemed to be a too liberal application in its Level 3 valuations, which they can set at any price they want to. But this problem is not limited to Goldman Sachs.

Just look how pervasive is Level 3 asset valuations at the nation's top investment banks:

Citigroup
Equity base: $128bn
Level three assets: $134.8bn
Level 3 to equity ratio: 105%

Goldman Sachs
Equity base: $39bn
Level three assets: $72bn
Level 3 to equity ratio: 185%

Morgan Stanley
Equity base: $35bn
Level three assets: $88bn
Level 3 to equity ratio: 251%

Bear Stearns
Equity base: $13bn
Level three assets: $20bn
Level 3 to equity ratio: 154%

Lehman Brothers
Equity base: $22bn
Level three assets: $35bn
Level 3 to equity ratio: 159%

Merrill Lynch
Equity base: $42bn
Level three assets: $16bn
Level 3 to equity ratio: 38%