Earlier this morning, Forbes ran an article highlighting how the problems in the credit markets will continue, and they may have be underestimated.

Wall Street has been moving billions of assets into a relatively new accounting category called “level 3,” a designation that the fair value of those assets, including subprime mortgages and derivatives, couldn’t be determined because there was no observable market for them. Those assets can sit in level 3 until the market for them springs back.

This points to a fundamental in valuation of any asset: it’s only worth what someone else is willing to pay.

Assessing the fair value of derivatives and thinly (if at all) traded mortgage securities holdings is far more art than science, with wiggle-room galore. Merrill said it marked its CDO holdings to “observable” market values, where there were prices to be observed. Otherwise, it used “quantitative” calculations: In other words, Merrill priced its own holdings based on a model.

Problem is, if every bank is pricing its own holdings to a model, there is no way of knowing whether the marks are accurate until everyone lays all the cards on the table. Merrill stopped short of doing that Wednesday. And so did everyone else.

Negative news like this is no good - anyone want a glass of Kool-Aid?

Posted by KoolAidMan on Thursday, October 25th, 2007 at 2:52 pm.