The key question is how many of the level 3 assets will actually default? Mogambo cites a Bloomberg which predicts up to a 16% default rate on US commercial paper. I really don't know if things will get that bad but if they do, the banks along with investors be hit very very hard.

In the Australian context most sythetic CDOs (Class 3 Assets) have exposure to firms directly impacted by the US sub prime crisis. For many instruments, this means partial or full capital loss if the default rate exceeds a certain level (usually between 7 - 11 %). In the case older, higher rated instuments, the banks issued capital protection to investors. This could represents a MASSIVE contingent liability, not be reflected adequately in the balance sheets of those banks.

In a nutshell, more central bank funded bailouts of major banks are on the cards. Money will need to be printed to cover the costs.