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March 16, 2008



The issue are the Level 3 Assets. Page 28 of FASB 157 (40 of the pdf) describes what level 3 assets are.

Level 1 assets are "mark to market" assets. There is a market price one can look up and see. Stocks are like this.

Level 2 assets are "mark to model" assets. There are observable inputs (like stock prices or LIBOR) and a formula to produce a value. Many derivatives are here.

Level 3 assets are the "mark to make believe" assets. These are the ones with no observable inputs. Many other derivatives are here. CDOs, SIVs and conduits are here.

I'd say it is less about FUD or uncertainty. There is no way to price them other than to believe what the seller wants to believe them. This is what hit the fan last year, and this was behind the 2 Bear Stearns funds being liquidated last year. In a market when no one can tell good assets from bad assets, the only smart thing to do is stay out of the market.

A significant amount of corporate profits in the last 2 years came from level 3. Make believe profits from make believe "assets" that never existed except other than to give an excuse for executive bonuses.

We're a lot more leveraged than in 87. That makes today's downside a lot greater than that time.


There's some mild (very mild) panic in the stock markets today, with financials getting hammered as expected, but I think it's possible there should be MORE panic than there is. Reason? The banks aren't buying it:

Financial trading and interbank lending almost ground to a halt on Monday as banks grew fearful of dealing with each other following Friday's near collapse of U.S. investment firm Bear Stearns

...banks' access to unsecured borrowing from other banks fell to a relative trickle and...analysts said any bank that had not already secured funding further than a week or so would struggle to raise cash at all.

"Bear's near-collapse and takeover accelerates the liquidity crunch and the money market crisis...Banks' risk aversion and sensitivity to counterparty risk should rise even further, leading to more pressure on hedge funds."



Herbert Hoover wasn't a Laissez-Faire free-marketeer (ok-neither is Bush but Bush is also not nearly as smart as Herbert Hoover) and had repeatedly attacked stock market speculation. Hoover was actually more in favor of the government bailing out corporations, due to oligopolistic market structure making industries susceptible to collapse, and letting them form private cartels to weather the crisis.

Hoover's bottom line was that liquidation - a course favored by Mellon - would result in a revolution but a welfare state would change America permanently for the worse. He sought a tenuous midle ground and failed.

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