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The effect of the US subprime crisis on the global financial system is apparently more profound than market participants anticipated until recently. We might witness the unwinding of another bubble after the real estate bubble made in the USA – the financial sector bubble.

Recent news showed that major US banks are significantly exposed to subprime mortgage holdings. Their European counterparts already documented similar news earlier this autumn. Finally, the Ponzi scheme of US real estate has collapsed and CDOs are finally marked to market (We always wondered how can there be so many genius CDO managers managing billions of dollars while marking their positions to target price and not to market!).

According to rules SFAS 157 and 159, US Banks will be obliged to reveal their illiquid assets (Level 3 assets) and their valuation techniques starting from November 15. The banks will need some time to clean up their balance sheets and recover from the negative effect the markdowns will have on their portfolios.

Due to the economic importance of the banking system which currently faces a major crisis – many of the large banks act as market makers for CDS as well, another aspect of how detrimental a collapse of one or more the major banks will be. CDS offer bond investors protection against a default of the issuer. A collapse of a CDS market maker could deprive the investors of this protection.

The US FED has already taken action and pumped liquidity into the mark......................

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