We’ve now ventured into the dangerous territory of financial accounting three times in the past two days to raise the possibility that the deep discount on asset backed securities obtained by Citadel when it bought E*Trade’s portfolio may amount to a major mark to market event for Wall Street. We knew when we started discussing this that the banks and brokerages would not be eager to make further write-downs to their ABS books. But what we didn’t know was that so many of our readers would be eager to provide the rationalizations for avoiding the mark downs.

We’re told that the bulk of E*Trade’s credit portfolio consisted of prime residential first lien loans. According to one E*Trade document DealBreaker has obtained, E*Trade had assigned a book value of $1.4 billion to mortgages rated AA or higher, $590 million were rated A, and $285 million were Triple B. With the secondary market for mortgages largely opaque—to the extent it exists at all these days—we thought it was rather obvious that a large public transaction in these securities should at least cause accountants to take a second look at their supposedly marked-to-market portfolios.

The main objection to viewing this as a mark-to-market event seems to be that because Citadel bought more than just asset backed securities and because the securities they did buy were a heterogeneous lot, it’s difficult if not impossible to derive a market price for the individual securities. This strikes us as a daring dodge but we’re trying to keep an open mind about this. Please feel free to explain in the comments below why further discounts of ABS books are not called for.

We greeted the news of announcement yesterday that Citadel had picked up an asset backed securities portfolio from E*Trade in our usual curmudgeonly style. While investors celebrated the news by pushing E*Trade’s share price up, we noted that this probably should have the accountants at many Wall Street firms scrambling to reassess their own ABS portfolios.

It turns our we weren’t alone on this. Paul Kedrosky filed a two-part analysis of the Citadel deal yesterday, and sounded many of the same notes.

“First things first, the price on E-Trade's ABS book. We just had a major mark-to-market event, in effect,” Kedrosky wrotes. “As more than a few people have argued to me via email, if most of the industry had to mark their ABS books to 27 cents on the dollar, the U.S. banking business would be in deep, deep trouble.”

So far the reaction from Wall Street has been mostly marked by silence, prompting one veteran Wall Streeter to remark over drinks last night, “How can you tell when a Wall Street bank is lying about the condition of its credit portfolio? It’s when they aren’t making any noise at all.”

E-Trade: Citadel Investment Analysis, Part 2 [Infectious Greed]