Rule change sounds alarm on Wall Street

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Wall Street banks will have to slash valuations on a further $400bn (£190bn) of risky assets as new US accounting rules come into force this week, triggering a likely wave of fresh writedowns.

The tougher standards will prohibit Citigroup, Goldman Sachs, Morgan Stanley and other US banks from setting values to sub-prime mortgages and other forms of exotic debt on the basis of "assumptions", compelling them instead to value assets at market prices - mostly far lower.

The change could not come at a worse time for banks already taking huge writedowns. The Dow Jones index has fallen 617 points over the past three trading days after rumours of huge bank losses swept Wall Street, ending with a sharp drop in the closing minutes on Friday that bodes ill for global equity markets this week.

In London, Barclays' share price fell 9pc at one point, causing trading to be suspended briefly. The bank denied reports that it is preparing to write off $10bn in sub-prime investments.

The new rule from the US Financial Accounting Standards Board - known as FASB regulation 157 - comes into force on Thursday. It affects the Level 3 tier of assets that are currently valued according to in-house models, or "mark-to-make-believe" in the words of Bob Janjuah, credit chief for the Royal Bank of Scotland.

Mr Janjuah says the FASB rule change could lead to a further $100bn of writedowns as banks are forced to come clean, with total losses climbing as high as $500bn across all forms of distressed credit. The top six banks alone have $365bn of assets in Level 3.

Although Level 3 assets are thinly traded, a series of ABX indexes give a rough guide to the market value of some $1,200bn sub-prime mortgage securities. These show that the lowest grades of 2006 vintage debt are worthless; BBB grades are down to just 18 cents on the dollar. AA grades are trading at around 60 cents, and AAA are near 85 cents.

Moreover, much of the entire $3,000bn global market for collateralised debt obligations is under strain. Merrill Lynch has declared a 30pc writedown on its holding of CDOs, offering a glimpse into the true values.

Few of the banks have admitted to losses on anything like the scale suggested by market prices. UBS is still booking its US mortgage debt at 90 cents on the dollar.

While nobody knows what lies under the Level 3 rock, the new rule could spell trouble. Citigroup has $128bn of assets in this category, or 205pc of its tangible equity. The figures for other banks are: Morgan Stanley $88bn, (275pc); Goldman Sachs $72bn (212pc); and Lehman Brothers $35bn (194pc).

The banks say a temporary panic has pushed prices below fair value, no longer reflecting likely default rates. A Goldman Sachs spokesman said the rules had compelled the bank to place quality assets in the Level 3 category that are not at risk in any way.

With the markets in an unforgiving mood, however, all banks are now assumed guilty until proven innocent.

In a rare piece of good news, The New York Times reported yesterday that Citigroup, Bank of America and JPMorgan had agreed terms for a $75bn rescue fund - or Super-Siv - to prevent a fresh fire sale of sub-prime debt. They are now in talks with 60 banks on plans to launch the scheme in December.

If it works, it will allow the lenders to feed out losses slowly, giving the market time to adapt. Critics say it is merely another attempt to cover the crisis by preventing "price ­discovery".

Telegraph