MONDAY, NOVEMBER 12, 2007

UP AND DOWN WALL STREET  

By ALAN ABELSON


Day of Reckoning

THE WORLD IS COMING TO AN END!

And if by some chance we're mistaken and it's only giving a great imitation, we'd just as soon be enjoying some pleasant distraction, like a visit to our drill-happy dentist, when the real thing comes along.

Pat Robertson's embrace of Rudy Giuliani to lead the GOP's charge in next year's battle for the presidency and Rudy's enthusiastic response would be enough to make us fear the end is nigh. Pat, after all, claims to be a confidant of God, and six years ago confirmed that the 9/11 attack was God's expression of anger at our benighted country for the terrible sin of allowing the American Civil Liberties Union to spread its corrupting influence in this proud land.

Rudy holds a more conventional view of the cause of 9/11, and evinces some minor deviances from Pat on a few domestic matters. But since Pat is willing to overlook Rudy's mundane heresies, he clearly believes it's time to lay aside earthly quibbles, to forgive and forget, because something very big is brewing.

We must confess that we haven't checked this out with Pat or even Rudy, let alone a still-higher authority, but, in any case, there are less celestial reasons for our existential concerns, and you needn't look beyond the global trading pits to spot them. The stock market is suffering one deep bout of vertigo after another. Crude has serious designs on $100 a barrel. Gold has roared through $800 an ounce as if the metal were going out of style. The dollar is changing with breakneck speed from the world's reserve currency into the world's disaster currency.

And those mammoth marvels of imprudence -- otherwise known as banks (and brokerage houses playing at being banks) -- are in a frantic scramble to see which gets the tin medal for the biggest write-down (that's bankers' euphemism for "loss") on loans gone sour. Friday's resumption of the long, bumpy ride down in the stock market got fresh impetus from the disclosure that Wachovia will take a $1.1 billion whack to its loan portfolio just to cover the damage in October, and rumors of kindred woes at Barclays.

But whether these are the end-days or merely the beginning-of-the-end days, don't anyone tell Mr. Bernanke; it might disturb him. For he convincingly demonstrated in his testimony last week before Congress that it's possible to be chairman of the most important central bank on the planet and seemingly not have a clue about what's happening to the economy, let alone what, if anything, to do about it.

At one point or another, he ventured that the economy would soldier on, if somewhat slowly for the next few quarters, unless, he cautioned at another point, it didn't; that inflation was a threat, but not a reality, at least not yet. And that the economy was perking along, nicely negotiating the shocks of the housing collapse, even as evidence to the contrary -- plunging consumer confidence, weak retail sales, dragging auto demand and all the grisly et ceteras -- mounted as he spoke.

Understand, if you will, we don't expect the Fed chairman to be omniscient or clairvoyant; but we do expect him, even if he doesn't know what's going to happen, at the very least to know what's going on. Nor are we demanding a foolish consistency; stuff happens, things change. All we ask is that if your opinions are firm, as Mr. Bernanke obviously feels they are, that they be fast as well, at least for as long as it takes to befuddle a bunch of slack-jawed congressmen.

All things considered, a Clueless Ben, we suppose, is preferable to an Easy Al, but incorrigible optimist that we are, we had hoped for something better. It's always possible, to be sure, that Mr. Bernanke knows more than he lets on. Certainly, the way the Fed has been opening the monetary spigot suggests that he may entertain greater anxiety than he's willing to exhibit publicly. Which may be effective in keeping the natives from getting restive, but it doesn't exactly enhance his credibility.

For sure, this is not the time for bromides. One needn't conjure up a doomsday scenario to realize that the economy and the stock market are on very thin ice. The Fed has plenty of company, both in Washington and Wall Street, in not fully grasping what a precarious condition we're in. A generation of living dangerously, often way beyond our means, as individuals and collectively, confusing credit with cash and leverage with assets, has brought us to this most unpretty pass.

The great boom in credit, a heck a lot of it shaky, has finally gone bust, and many of the remarkable creations it engendered, such as monster global bull markets in equities and housing, are suddenly on shifting sands. It's becoming apparent that a day of reckoning so long delayed, so many times interrupted, is at hand.

Obviously, we don't think, even in a figurative sense and except possibly for the financial elite who run hedge funds and private-equity money, the world is coming to an end. But our conviction is strong that we are entering a New Era. And not, regrettably, the kind of New Era that sent investors' pulses racing and fed their gaudiest dreams of avarice when that phrase was last a byword -- and, even more, a buy word -- on Wall Street. Ah, those were the days.

GISELE BUNDCHEN IS A MUCH-IN-DEMAND BRAZILIAN who commands a king's ransom to do her modeling thing. We admit that Gisele was completely unknown to us (which, it appears, and we say this somewhat ruefully, didn't hurt her career one whit) until her highly publicized pronouncement that henceforth the king would have to pay his ransom in euros, not dollars, for her services.

This prompted a number of observers, including MacroMavens' Stephanie Pomboy (who, incidentally, wowed 'em at Barron's recent investment conference) to speculate as to whether Gisele's disdain for the dollar meant that the greenback's plight was so widely recognized as to signal a bottom. Stephanie, in her usual deft fashion, dismissed this possibility (as did Peter Schiff in a recent commentary, noting "the only notable bottom here belongs to Gisele herself").

We've never really bought the condescending notion that when Main Street knows it, it's no longer worth knowing. And in the case of the dollar, we doubt if there's a sentient being anywhere who's unaware of its horribly reduced status. And since the decline and fall of the dollar apes the woes besetting the economy at large and the financial system in particular and we see no immediate relief in sight for either, Gisele, we submit, is right on the money.

A recent analysis by Bob Janjuah -- the Royal Bank of Scotland's chief credit strategist -- as relayed by Bloomberg, powerfully supports our forebodings for the credit markets and, by extension, the economy, the stock market and the not-so-almighty dollar. Before the dust clears (and the bodies are all carried out), he reckons that credit losses will run between $250 billion and as high as $500 billion.

More specifically, Janjuah predicts that U.S. banks and securities firms are looking at perhaps $100 billion of write-downs on so-called Level 3 assets, as the new Financial Accounting Standards Board rule 157, slated to go into effect this week, takes it inevitable toll.

FASB dicta call for Level 1 assets to be marked to market. No big deal, since these are instruments that are traded in a familiar market and consequently are easy to get a quote on. Level 2 assets aren't very actively traded, and hence it's not a cinch to get a reliable price; however, they consist of parts for which pricing information is available and which permit a reasonably reliable estimate of the asset's value. An interest-rate swap has been cited as an example.

That brings us to the tens of billions of Level 3 assets. Typically, these are packages of stuff like mortgages, credit-card receivables, leveraged loans and various and sundry other things -- a bit of the lending kitchen sink, in other words. Market pricing is pretty much nonexistent, and such assets are valued at more or less what management says they're worth. In Janjuah's sardonic phrase, Level 3 assets are "marked to make-believe."

And here's where the new rule is destined to make life a lot more difficult for holders of Level 3 instruments, by mandating far more stringent means of figuring their value or else. And the or-else could translate into writing them down. Reason enough why no one seems in a particular rush to buy such assets.

According to Janjuah's calculations, Morgan Stanley, which is still grimacing over a recently disclosed trading loss of $3.7 billion, has 251% of its equity in Level 3 assets. At Goldman Sachs, the Level 3 commitments run 185% of equity. At Lehman, such assets are the equivalent of 159% of equity; at Bear Stearns, 154%.

Citigroup, which owns up to something like an $11 billion hit from subprime and other bum loans, a dismal total that occasioned the exit of its top man, has Level 3 assets equal to 105% of its equity. Rather ironically, Merrill Lynch, which is upward of $8 billion poorer after taking its bitter medicine to purge itself of overvalued subprime and assorted other loans, and whose CEO also was shown the door, has Level 3 loans equal to 38% of its equity. That makes it the least vulnerable of the major lenders.

We're not suggesting, need we say, that every Level 3 security on a bank's books is at risk or will have to be written down. But in total, they represent one massive pile of uncertainty, of which the lenders and the credit markets already have more than a surfeit, thank you.


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