The biggest securities houses of Wall Street and the City of London are in a quandary. How do they fairly value the billions in illiquid securities, loans and commitments sitting unloved on their books? The third-quarter reporting season begins next week, with Lehman Brothers first out of the stalls. The intense interest in all banks from outside shareholders is matched by a frenzy of activity within by finance people, auditors and lawyers. These are no ordinary results. They will not only dictate sentiment in the financial markets for months to come but will also help to determine the bonuses and job prospects of a quarter of a million of the highest-paid people on the planet. The most senior people are taking a particular interest, which is not surprising since they can be jailed under Sarbanes-Oxley if they knowingly mislead shareholders.

Josef Ackerman, chief executive of Deutsche Bank, set the scene two weeks ago, urging fellow bankers not to muddle through but to write down assets to true market values. One of London’s top bankers has echoed that view, saying he is worried that banks may be “tempted to obfuscate and airbrush” the true picture.

This week Bob Diamond, president of Barclays, put some of the grisliest fears to rest, saying Barclays Capital had valued all its positions according to prevailing market prices and still managed to turn a profit.

Everyone is coming to this from a different position. Mr Ackerman is thought to be sitting on some of the most unsellable debt and doesn’t want to be alone in admitting as much. Mr Diamond is fighting Europe’s biggest bank takeover battle and needs to restore complete confidence in his balance sheet.

Background

• Elephant slumps in wake of crunch

• Heads on the block, investors call for change

• Credit crunch forces Delek to leave property deal

• US rate cut looks certain after new data

• Bank of America to axe 3,000 after 'our errors'

Background

• More pain for private equity industry

• Russian state bank poised to boost liquidity

• House prices‘to stay flat for years’

• Will soaring oil pump up inflation?

• US bank slump goes on

Black clouds loom on horizon

For the first time in 15 years, I am seriously worried about the outlook for the economy, the housing market and sterling

Float on the job market

Don't believe the scary headlines. It's not the worst time to consider a career in banking

The problem lies in valuation. There is no market in many of the complex securities and derivative positions held by banks even at the best of times. Even the values of those debt securities where prices are quoted are suspect. On the last day of the quarter, Friday August 31, the day before the Labor Day weekend, markets were thinly traded. Spreads – the difference between buying and selling prices – ballooned. Screen prices were meaningless.

Losses on securities intended to be held to maturity don’t necessarily have to be disclosed. Asssets where there is no market or where the market is deemed not to be active can be valued according to model. It is all very subjective.

The banks are in for a difficult month. Nasty losses may be greeted with a further souring of sentiment. An absence of red ink and bankers will be accused of being in denial.

But erring towards the conservative view, even if it means writebacks when markets stabilise, has to be the lesser of two evils. And until banks start displaying their wounds, they will get little sympathy from politicians, the public, or from central banks, whose goodwill they so desperately need.

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