You heard it first here on Monday but what was until last week an obscure and arcane corner of accounting and asset valuations (level 1, 2, 3 securities, the new FASB 157 regulation) is now a front page issue on the mainstream press and across Wall Street.

Suddenly markets and investors are discovering that many financial institutions were parking a large fraction of their asset in the level 3 bucket where they avoid using market prices to evaluate such assets but rather rely on “model valuations” and “unobservable inputs”. But now the forthcoming FASB 157 regulation will prevent them (unless heavy political lobby leads to a postponement of its implementation on November 15^th) from playing such accounting tricks and force them to use market prices – when available even in illiquid market conditions – to price these assets.

And guess what now? New reliable estimates suggest that using these market prices – rather than level 3 model gimmicks - will lead to losses of another $100 billion on top of hundreds of billions of subprime losses. And some market participants are already talking – quite realistically – about total losses from this credit disaster in the $500 billion range.

Indeed, losses of the order of $500 billion are actually quite reasonable and likely once you account for all the losses from subprime, near-prime, prime mortgages, CDOs, CLOs, failed LBOs, auto loans, credit cards and other consumer credit, commercial real estate loans, a variety of asset backed securities, level 3 asset value recognition at market values, and other financial market losses. Subprime alone is now estimated to lead to losses as high as $238 billion based on a mark to market analysis.

Indeed, as reported by Bloomberg today:

Banks Face $100 Billion of Writedowns on Level 3 Rule

By John GloverNov. 7 (Bloomberg)

-- U.S. banks and brokers face as much as $100 billion of writedowns because of Level 3 accounting rules, in addition to the losses caused by the subprime credit slump, according to Royal Bank of Scotland Group Plc. The Financial Accounting Standards Board's rule 157 will make it harder for companies to avoid putting market prices on securities considered hardest to value, known as Level 3 assets, Royal Bank's chief credit strategist Bob Janjuah in London wrote in a note today. The new rule is effective Nov. 15. ``This credit crisis, when all is out, will see $250 billion to $500 billion of losses,'' Janjuah said. ``The heat is on and it is inevitable that more players will have to revalue at least a decent portion'' of assets they currently value using ``mark- to-make believe.''

Wall Street's biggest firms have written down at least $40 billion as prices of mortgage-related assets dwindle because of record foreclosures. Morgan Stanley, the second-biggest U.S. securities firm, has 251 percent of its equity in Level 3 assets, making it the most vulnerable to writedowns, followed by Goldman Sachs Group Inc. at 185 percent, according to Janjuah. Morgan Stanley fell $3.63, or 6.7 percent, to $50.85 at 2:14 p.m. in New York. The New York-based bank is down 24 percent this month. New York-based Goldman Sachs dropped 3.2 percent to $216.08. Morgan Stanley may write down $6 billion of assets, David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, said yesterday. Merrill is Healthiest Citigroup Inc., which this week said losses from subprime assets may be $11 billion, has 105 percent of its equity in Level 3 assets, Janjuah wrote. The New York-based bank fell 2.51 percent to $34.20, a four-and-a-half year low. Merrill Lynch & Co., which wrote down $8.4 billion of subprime mortgage debt and other debt securities, has Level 3 assets equal to 38 percent of its equity ``and may well come out of all of this in the best health,'' Janjuah said. Merrill lost 4.36 percent at $53.91.

``If you look at the writedowns just at Citi and Merrill already it's about $20 billion, so $100 billion may be on the conservative side globally,'' said Sajiv Vaid, who manages the equivalent of about $10.5 billion of corporate debt at Royal London Asset Management in London, a unit of the U.K.'s biggest customer-owned insurer.

The losses are likely to hurt shareholders more than bondholders because the banks may be forced to sell stock to raise additional capital, Vaid said. `Unobservable' Inputs Banks may be forced to write down as much as $64 billion on collateralized debt obligations of securities backed by subprime assets, from about $15 billion so far, Citigroup analysts led by Matt King in London wrote in a report e-mailed today. The data excludes Citigroup's own projected writedowns.

Under FASB terminology, Level 1 means mark-to-market, where an asset's worth is based on a real price. Level 2 is mark-to- model, an estimate based on observable inputs and used when there aren't any quoted prices available. Level 3 values are based on ``unobservable'' inputs reflecting companies' ``own assumptions'' about the way assets would be priced. ABX indexes, which investors use to track the subprime-bond market, are showing ``observable levels'' that would wipe out institutions' capital if the benchmark's prices were used to value their Level 3 assets, according to Janjuah.

The indexes have tumbled this year because investors expected rising numbers of borrowers to default on home loans, cutting the cash flowing to the bonds that package the mortgages. Lehman Brothers Holdings Inc. has the equivalent of 159 percent of its equity in Level 3 assets, and Bear Stearns Cos. has 154 percent, according to Janjuah's note, called ``Bob's World: Feast and Famine.''