Part of the reason we are having a melt down in the financials right now is that the market does not understand the position of the financials. For example in mid July of 08 Merrill wrote down 9.8 billon of assets only to be followed by another 5.7 billon on July 28th, 2008. As they say a billon here and a billon there and after a while it becomes real money. After the announcement, the CNBC pundits came out and openly questioned the honesty of Merrill Lynch’s CEO. I believe John Thain is an honest man who has been put in a horrendous position by his predecessors- as he has been hired to clean up the sub prime mess. The problem that Merrill faces is that if they were completely open with the public about the true nature of their losses, the market would be horrified and probably send the stock straight to zero. So hence, Merrill is forced to be discreet and hide their problems on their balance sheet and the whole market knows this.
The only reason why financial markets work is because the market has to believe in the audited financials. For the markets to work, people have to believe in their counterparts and the companies listed on the exchanges are being truthful, and to the extent they are not; why would anybody invest one cent in the markets? To be even more clear for the financial markets to work- there has to be a high degree of honesty and truthfulness. First and foremost for somebody to want to buy your stock the investors have to believe you are being truthful about what you are earning. So in reality- what is most important about the markets is not how much money a company can make but really how truthful they are in reporting those numbers. What the markets are suffering right now is a lack of credibility in what the financial houses are reporting and these have long term consequences.
After the Enron and Arthur Anderson debacle in 2001 the markets went into a free fall, partly because of the tech bubble and partly because people no longer had faith in what the companies were reporting. The congress passed the Sarbanes-Oxley Act which forced US listed companies to be more truthful in their reporting or face the consequences. Amazing as it seems, we are facing the same crisis for the same reason. What is different this time is that the financial houses are not stand alone companies, they are the engines that finance the growth of the U.S. and to the extent they can not manage to tell the truth about the nature of their losses, they have grave and serious consequences on each and every citizen.