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Thursday, November 01, 2007


The Wall Street Journal's lead editorial yesterday "Wall Street Reckoning," should be must reading for investors. It warns that while Merrill Lynch rightly came clean with its structured investment losses, "some other big banks haven't been so candid." The editorial adds: "We suspect some of the tightest white collars these days are over at Citigroup, America's largest bank and one with some of the biggest subprime exposure. Something like $80 billion worth of so-called ‘structured investment vehicles' sold in Citi's name are wobbling, yet the bank is doing all it can to avoid absorbing those losses on its own balance sheet."

The story is eerily all too familiar: A corporation plays fast and loose with the valuation of its assets hoping its "strategic investments" will finally pay off. But the real value of the investments continue to plummet and the truth must finally be revealed.

Presto, another bubble bursts.

Hocus pocus accounting played a significant role in the collapse of some companies. But the accounting shenanigans were initially touted by Wall Street. Consider an April 2000 Salomon Smith Barney reseach report on "March First," an internet and technology services company that ultimately went bust.

Over the last decade the most common valuation method for technology providers has been P/E multiples relative to the projected growth rate. However in late 1999, the investment community adopted revenue multipliers as a valuation methodology for the Internet and Technology providers...The application of revenue multiples led to record valuation metrics for some ITS providers, particularly those with fast revenue growth and limited earnings projections.

Avoiding a liquidity crisis was likely Enron's motivation when they orchestrated the Nigerian barge transaction with Merrill Lynch or when telecom firms engineered sham "revenue swaps" at the end of quarters to meet Wall Street expectations. There is no barge or revenue swaps in today's market, but there is the Paulson-blessed "super-conduit" fund that will supposedly buy up the bad debt and hopefully allow banks to avoid their day of reckoning.


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