Truth-telling is the secret to recovery

It's not over.

Despite some recent relief for financial stocks, Oppenheimer & Co. analyst Meredith Whitney says the financial markets won't be able to stabilize until there is more truth-telling.

Rather than trickling out write-downs and sour news, Whitney says, banks need to "get real" about their "true asset values."

She thinks they are still embracing an overly cheerful outlook and valuing their mortgage-related assets too high. As a declining housing market takes its toll on their mortgages, she expects "bank stocks to head lower."

It looks as if home prices could fall 33 percent from their peak if the futures market is reflecting the future correctly. The futures, based on the Case-Shiller housing index, already show home prices down 15 percent. But Whitney, who has been ahead of many of her peers in detecting financial troubles, thinks homes will fall even more than 33 percent before they ultimately bottom.

That's because a dangerous spiral is now fully in force - pulling at the strength of banks, housing, and the economy as a whole. Critical in the picture is the fact that almost a $3 trillion part of the housing funding system has all but disappeared. It's called securitization, or the process Wall Street previously used to buy mortgages from banks, bundle the loan payments into bonds, and sell the bonds to investors.

The bonds were popular with investors until the housing bubble burst in 2007. Then, investors discovered that Wall Street had done a shoddy job - bundling together loans that couldn't be repaid. As a result, the bonds have plunged in value, and investors won't buy new ones.

Without that $3 trillion funding system available for mortgages, home buyers and banks are deprived of funds they need. The securitization market provided close to 85 percent of U.S. mortgages over the last decade.

"Since 70 percent of U.S. homes are mortgaged, a shutdown in such a crucial part of the lending market has enormous consequences," Whitney said.

Last spring, Treasury Undersecretary David McCormick and Federal Deposit Insurance Corp. Chairwoman Sheila Bair said in interviews that they thought the housing market would need a healthy securitization market again so housing could recover. They thought that with time, investors would buy the bonds again.

The issue is so serious that the Federal Reserve sought insight into the problem at a Chicago conference on the credit crunch recently.

A panelist, Drexel University finance professor Joseph Mason, said that in the interest of repairing the housing system, it would be essential to restore the securitization system. To do that, however, Wall Street would have to change. Instead of keeping information about mortgages in bonds confidential, Wall Street would have to disclose information continually to investors so they felt confident about buying the bonds. The industry refers to this as "transparency."

At credit-and-debt conference in March in New York, Richard Field, founder of TYI L.L.C., of Needham, Mass., explained a system that would tell investors daily how many mortgage payments were being made on time. Current information is available monthly - too slow with housing declining so quickly.

Meanwhile, banks are left with troubled mortgages and mortgage-related securities on their books.

Each has its own expectations for the housing price declines, and Whitney says they are underestimating the declines.

Wachovia Bank, for example, is expecting the most modest decline - 12.9 percent - while Bank of America is estimating 30 percent and Citigroup 20 percent.