I've said it before and I'll say it again,"Wallstreeters have no overseeing authority as to how to value their financial instruments."
And have a read of this from Martin Hutchinson-
Goldman Sachs, for example, reported this week that the “Level 3” assets in its books, those for which liquidity is lowest and valuation most difficult, had jumped by a third in the quarter to $72.05 billion. These “Level 3” assets presumably don’t include Goldman’s multi-billion dollar holding of the Industrial and Commercial Bank of China, quoted daily on a stock exchange, however over-inflated its share price and illiquid its trading market. Instead, they appear to represent mostly derivatives and securitization assets linked distantly to mortgage loans and leveraged buyout deals, whose valuation is carried out by the operating unit itself, based on the price at which it would have to sell the asset to preserve its bonus pool from unexpected losses.
Set against Goldman’s capital of $36 billion, that $72 billion is a frightening figure. At some point, probably in a downturn, the real value of those “Level 3” assets will have to be recognized. No doubt the resulting losses will be written off against capital but even Goldman’s brilliant and gloriously paid accountants will find it difficult to write off $72 billion of losses against $36 billion of capital.
Corporate profits are Wall Street’s main justification for the current over-inflated level of the US stock market; they have been increasing in every quarter since 2002 and are held to justify an S&P500 earnings multiple of “only” 18. However, Thomson Financial reported Thursday that third quarter earnings, those currently being reported, were likely to come in fractionally below second quarter earnings, for the first time since 2002.
If that prediction is fulfilled, and we have now passed the peak of earnings in this cycle, then unexpected losses and the need to return corporate accounting to a reasonably conservative basis will make the downward slope in earnings long and steep, so that even if 18 times earnings were an appropriate level, it would imply a massive drop in the stock market. Such a drop in the stock market, particularly if accompanied by an inflation-caused drop in bond markets, will decimate Wall Street’s profits, throwing overpaid bankers out of work and further pressuring consumer spending. It is a vicious circle, spiraling ever more rapidly into an almost (but not quite) bottomless pit.
It might be time to speculate in a few long term put options – or move your money overseas, but where?