A few days after the Bear Stearns bailout was first announced, there was generalized panic that another big bank, probably Lehman Brothers, would go under. Lehman’s default insurance rates were soaring and its stock was plummeting. Lehman is a much bigger bank than Bear, with much more diversified and global business, so the market really risked melting down. Then Lehman and Goldman Sachs released their quarterly earnings reports and showed “not as bad as expected” earnings, and the market was euphoric.

Wait a minute. Why is anyone believing anything they say about the state of their finances?

I find it interesting that this post at Conde Nast examining Lehman Brothers’ statement hasn’t gotten much play. Lehman Brothers is cooking the books. As Conde Nast says, “the picture emerging is of an investment bank that is dancing as fast as it can.” Their assets increased when they should have decreased. They’ve moved some kinds of debt into the equity column. Their leverage has increased to almost 32-to-1. And they are booking writedowns on their own bad credit as profit. As this blogger explains, it would be as if you borrowed $100 from a friend, who decided you were probably only going to repay $95, and you booked the difference as a profit. Normally, that’s not a sign of your financial health. The same writer also points out that Goldman Sachs didn’t mark down any of its commercial real estate assets, though the commercial property market is tanking, and coincidentally, moved $9 billion in commercial real estate from its Level 2 assets to its murkier Level 3 assets sheet for this report.

A lot of what is going on is a confidence game. If the market can credit the banks until asset prices recover, the banks can emerge from this crisis intact. Meanwhile, all of them are tapping every lifeline the central banks are throwing them. And it’s not all down to confidence. Declining property values are going to inflict real losses on banks, and the recession is only beginning, so expect more falls in property values, foreclosures, higher rates of negative equity, and possibly a “jingle mail tsunami” as borrowers return the keys to their negative equity homes.

Now, the fed and the government can intervene, ultimately, to buy out the mortgage market. But this is going to be tremendously expensive, at a time when US fiscal capacity is already very stretched. On top of massive deficits, and the cost of the Iraq war running into the trillions, US infrastructure is under tremendous strain. Recently, the CEO of UPS said the US needs to invest $1.6 trillion over the next five years to upgrade its decrepit transportation network.

I come back to some points I have made elsewhere. An optimistic scenario has to deal with the following challenges.

• declining housing values and high rates of negative household equity
• increasing default rates in the context of a recession with an unclear horizon
• securitization of mortgage products which has proliferated exposure
  to toxic financial products
• massive leverage in the financial system
• uncertain value of default swaps and other over the counter derivative and hedging products — i.e. counterparty risk and uncertainty about whether claims can be met, and the difficulty of establishing clearing prices.

As long as declining asset values lead to margin calls, selling will continue. Because exposure to these toxic products is widely held and hedging is of uncertain value, many funds are caught in the net. They are facing margin calls and will have to sell all kinds of assets, not just mortgage-backed securities, and financial contagion will spread the crisis from one sector to another. We are going through massive deleveraging. It’s very difficult to construct a plausible financial optimist’s scenario that doesn’t see further troubles ahead.

However, bad news for capitalism isn’t necessarily good news for the left. In fact, the best news for capitalism is the continued disorganization, ideological weakness, and lack of imagination of the left.

Corvin is an activist and writer based in Toronto. Currently he is working on the Environmental Justice Organizing Initiative to help build an organized movement on climate change rooted in a class, race, anti-colonial, and gender analysis. Read other posts by Corvin Russell.