Level 3 fraud on Wall Street

January 4, 2008

When normal people lose money on an investment, they can’t withdraw their assets from the market and assign them any value they choose. The only way those assets are valued is by comparing them with current market transactions — the last value at which it was traded. But for banks the rules are different, for many years they have been maintaining what is referred to as “level 3″ assets that have completely made up valuations.

Level 3 assets are those that trade so infrequently that there is virtually no reliable market price for them, and valuations for these assets are based on management assumptions.The credit crisis has sparked concerns about the value of some of the assets investment banks hold on their balance sheets. Investors and analysts have been especially worried about banks’ exposure to turmoil in the mortgage market and recent trouble in the financing of big leveraged buyouts.

from MarketWatch

The explanation is fairly straight forward — these are assets that don’t trade often so it’s difficult to know their true market value… but what if the reason the assets aren’t trading is because nobody wants them? Lately, these banks have been moving their sub-prime garbage to this category in order to legally assign whatever value they need to maintain a reasonably healthy balance sheet. The worse their “credit crisis” becomes the quicker their level 3 will grow. There is only one word to describe this phenomenon — fraud.

CNBC