Citigroup's bombshell that it faces as much as $11 billion more in credit losses has made one thing clear: No one really knows what's hidden in the subprime bond basement.
JPMorgan thinks the financial services industry is sitting on $60 billion in undisclosed losses. Bill Gross, manager of Pimco, the world's biggest bond fund, characterizes the U.S. subprime issue as a "$1 trillion problem."
Whatever the number, the lack of clarity is raising worries that Wall Street and investors don't have the basic information to judge the severity of the current crisis.
Two massive write-downs by Citigroup since early October and a rash of related losses for Merrill Lynch, the world's biggest brokerage, illustrate how difficult it is to evaluate risky debt tied to subprime mortgages.
Analysts and investors expect the situation to worsen as banks reveal more losses and rating companies continue to downgrade some top bonds that trade like junk.
The bigger write-downs stem from banks' exposure to giant, complicated bonds. Many investors didn't realize they could lose their entire investments due a decline in subprime loan values that was largely masked by the repackaging of the bonds and opaque accounting.
"We will see a train wreck happening, if the industry does not get together to develop a systematic way to deal with these distressed loans," Sheila Bair, chairwoman of the Federal Deposit Insurance Corporation (FDIC), said in an interview Monday.
"Right now, nobody knows what is going to happen," Bair said. "If this is a train wreck, you are just going to see greater skepticism about the value of these mortgages."
Citigroup said on Sunday it expected potentially $11 billion in losses from its exposure to bad mortgages which banks had bundled together into large bonds known as collateralized debt obligations, or CDOs. A month ago Citigroup said it had cut the value of those assets by $5.9 billion.
Merrill last month announced a $7.9 billion write-down, up from $4.5 billion from just a few weeks earlier.
"No one is going to believe anybody anymore [about CDOs]," said Cantor Fitzgerald Chairman and Chief Executive Howard Lutnick. "It's not just about the rating. You have to run your own math and come to your own view."
Lutnick, whose firm controls one of the world's largest bond brokerages, said the CDO market has shut down.
"The big CDO market is gone," Lutnick told the Reuters Finance Summit. "The buyers are gone."
Big Banks' CEO Exodus
During an interview on CNBC, Pimco's Gross said that the subprime mortgage market is a "$1 trillion problem" made up of "garbage loans."
Citigroup and Merrill's revelations led to the departure of Citigroup's CEO Charles Prince on Sunday, about a week after the resignation of Merrill's CEO Stanley O'Neal.
The subprime problem has hit every Wall Street institution, from Goldman Sachs to Lehman Brothers to Bear Stearns.
"A lot of people are saying they're clearing the decks, but values are still declining, ratings are still falling and we're going to have more losses," said Josh Rosner, a mortgage specialist at Graham Fisher in New York. "We're not in the clear."
Banks and brokerages generate fees for creating these structures which they then sell to investors. As the sales dried up, they are forced to hold onto CDO assets which are rapidly losing their value.
Even Citigroup appeared to have little faith in its own numbers and what they may mean. It cautioned that write-downs and the the impact on Citi's financial results for the fourth quarter "could differ materially" from its estimates.
Of course, the market could recover and Citigroup could sell its positions. However, right now there are "no observable trades" for the CDOs Citigroup holds, according to its chief financial officer.
Analysts fear a flood of rating downgrades may spur liquidation of CDOs and add to selling pressure, delaying any market recovery. Rating companies Standard & Poor's, Moody's Investors Service and Fitch Ratings are re-assessing their ratings on hundreds of CDOs and subprime-related debt.
"The combination of investor capitulation and illiquidity is not a good one, and could put further pressure on prices," according to Christopher Flanagan, a JPMorgan analyst. "Forced selling on downgrades remains a risk for AAAs."
Fitch Ratings cut Citigroup's credit rating Monday to "AA," its third-highest grade, from "AA-plus," citing "severe pressure" on capital markets operations and "an inhospitable consumer credit environment" as mortgage delinquencies soar.
S&P also said it may cut its own "AA-plus" rating.