The million $ question.

Have we hit rock bottom?

We have not.

As job losses accelerate (or even just accumulate) there will be more defaults to come on prime, Alt-a, auto loans, credit card loans, student loans, helocs, and any type of (semi excessive) lending that was allowed over the last decade. The products derived on all these credit are structured in such a way that the most senior tranches have the most credit protection (in other words, they are last to absorb any kind of loss). However, currently we are seeing CDO transactions (CDO's are a good benchmark, as they can entail the entire list of underlying collateral; from bank trust preferred stocks to Argentinean cattle) experiencing senior overcollateralization ratio's close to 20%. In other words, a 80% mark down is lingering. That said, the haircuts that have to be taken on collateral that suffered a ratings downgrade below a certain threshold could make it look like this downgraded collateral has no value left in it at all. All critique on Moody's and S&P's aside, even for a skeptical investor it would seem hard to believe these assets have became absolute empty clamps.

Now, the point I am trying to make, there is no such thing as a "safe structured product". We would not have structured it in the first place if the underlying was risk free. Are banks aware of this? I want to believe they are. But I am not sure. I spoke with a top banker of a European bank just a few weeks ago and he suggested just leaving everything at par on the books. "We're not looking to sell in this kind of market anyways, so we might as well hold to maturity" Obviously, this is impossible, but the deals will stop generating cash flow (interest and principal payment) at some point. As of today, a lot of large financial institutions are keeping these assets at par on their books. Even as we can assume with near certainty that cash flow will dry up for a lot of these deals.

Accounting regulations are supposed to push firm to mark these assets to market, but regulation left so many loopholes and ambiguity, we are far from marking to market. This is not a secret. Governments and oversight boards and institutions would commit a massive financial hara-kiri by imposing strict compliance of mark to market right now. Rather assets are kept at premiums that allow financial institutions to stay in a coma type of sleep, a few quarters, months, or even days away from final insolvency.

If we think of the shadow banking system in this context, the eventual damage we can expect is simply not comprehensible. Were regulation on banks is still somewhat existing; hedge funds, money market managers, investment banks and others alike lack any form of transparency. More so, a lot of the funding that is parked at these institutions has a limitation on the withdrawal of it. Once expired, we can expect margin calls to knock down a significant part of this market. Which in return will affect the banking industry.