End of Quarter Reckoning Awaits Wall Street

A decent bounce on Wall Street last week carried the S&P 500 to a spirited gain of 2.3%, while the tech-heavy Nasdaq jumped nearly 3%.

So the inevitable question that the talking heads on CNBC are asking today: is the worst of the selling behind us, and has the correction ended? I’m willing to wager that the answer is no, here’s why.

Several of Wall Street’s biggest investment banking firms – who have been caught at ground-zero of the sub-prime storm – are closing out their third fiscal quarter at the end of this week. Some of these firms including: Bear Stearns, Goldman Sachs and Lehman Brothers have either already reported losses related to leveraged bets on mortgage loans or derivatives tied to them.

But the complex web of derivatives that’s been built up over the years includes many securities that are difficult to accurately value in the best of environments, given the complexity of these securities and the infrequency of trading in them. Add in a credit market that has virtually ground to a halt in recent weeks and you’ve got a recipe for lots of “unknowns”.

The Credit Crunch Coming Out Party Fast Approaches

At quarter’s end, all public companies, including those mentioned above, must close their books and make every effort to account for all outstanding investments by “marking to market” the value of those holdings – including derivatives. By SEC rules those firms closing their books at the end of August have 45 days to file their full financial disclosure documents.

This tells me that starting in early September and running through mid-October – when the 45-day deadline passes – there will be the ever present potential for lots of little hand-grenades going off on the balance sheets and income statements of Wall Street firms.

Then, many of the nation’s biggest banks including Bank of America, Citigroup and JPMorgan Chase, who close their books at the end of September, will have till mid-November to fess up their own sub-prime sins.

It ought to make for an interesting Autumn on Wall Street – better stay on your toes this Fall!

Comments

[Bill Yates]

Nice take, Mike. I agree that there's more to come, particularly in September. And many derivatives will have to be unwound, releasing their bundled-up risk back out into the market. Here's a book on the subject I just ordered, written by the former head of derivatives for Citigroup -- Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ('06), by Satyajit Das.