Sometimes a story comes along and it is immediately obvious that it will explode. Earlier this year, it was the subprime crisis. Today, it is the level three crisis.
What is the level three crisis? Under a new reporting requirement, banks need to give more transparent information about the valuation of their assets. Level three assets are the most obscure and troublesome. These are bank assets that are not tradable and can not be properly priced using market prices. Guess what, Wall street banks appear to be holding much more than originally thought.
What kind of assets normally end up being classified as level three? No one knows for sure, but it is a fair assumption that all those toxic subprime CDOs will be classified as level three.
More worryingly, the major banks are reporting large increases in their holdings of level three assets. Just take a look at some of the growth of these assets between q2 and q3 this year. For example, Merrill Lynch reported a 69 percent increase in level three assets. Overall, the stock these dubious assets represents around 70 percent of Merrill's capital.
Increasing awareness about these illiquid and untransparent assets has not impressed equity markets. Bank stocks are down 12 percent since the end of September.