One reply to our insistence about this Citadel discount thing has been to call it an "Armageddon Scenario" that is simply too horrible to contemplate. An old friend just wrote to us that what's keeping the banks from marking down their CDO portfolios based on Citadel is not wishful thinking but sheer terror.
What are they afraid of? Well Peter Cohan has helpfully showed exactly what there is to fear. In a recent column on blogging stocks he says that the capital of three banks would be wiped out if that 27 cents on the dollar valuation was applied to their Level 3 assets and written off from their most recent capital levels.
So who are the three banks who are imperiled by the 27 cents? After the jump, check out Cohan's list.
* Morgan Stanley (NYSE: MS): -$29 B (subtract 73% of Morgan Stanley's Level 3 assets of $88 billion -- or $64 billion -- from its capital of $35 billion).
* Goldman Sachs (NYSE: GS): -$14 B (subtract 73% of Goldman's Level 3 assets of $72 billion -- or $53 billion -- from its capital of $39 billion).
* Bear Stearns (NYSE: BSC): -$2 B (subtract 73% of Bear's Level 3 assets of $20 billion -- or $15 billion from its capital of $13 billion).
Cohan includes lots of caveats in his post, so you should read the whole thing before massively shorting Goldman. But this is probably the most plausible explanation we've come across for why there is such adamant resistance to treating the Citadel discount as a pricing event.
Could Citadel's valuation of E*Trade's CDOs wipe out capital at three big banks? [Blogging Stocks]