Two More Wall Street Dominoes Fall

Both Mendelsohn and Pavlik agree that the repercussions for the collateralized mortgage obligation and credit default swap market are enormous and could take even longer to work out, given the size and complexity of each. "We still have many these toxic debt instruments out there in companies that have written credit default swaps against other firms that might not even be able to back those swaps," Pavlik says.

Now attention has turned to the health of insurance colossus AIG (AIG Quote). Already, the company has reached out for a $40 billion bridge loan from the central bank in order to recapitalize, but a 45% decline in the stock price Monday says all that needs to be said about the market's expectations the loan will secure its future. AIG now faces a major restructuring that will require the sale of assets in order to fend off a ratings downgrade from Standard & Poor's.

"Right now the biggest problem is AIG," Mendelsohn says. "Lehman and Merrill are done. Now the focus moves to AIG and their problems recapitalizing. Their doors are shut to potKnowing their derivatives operations and their security business, they have a tremendous cross-party risk."

In addition to AIG, Wachovia (WB Quote) and Washington Mutual (WM Quote) are also being viewed with caution.

"We're running out of banks that are strong enough to take over the weak," says Mendelsohn. "With the credit market contracting the way it has, businesses are going to have trouble getting loans. Anyone that needs to borrow money due to cash flow issues is not going to be able to get it. This economy is going to come to a standstill."

But market analysts are not on the same page when it comes to the market's prospects for the next six to 12 months should the dominos keep tumbling. Pavlik says that if a washout were to come on a short-term basis, the market could see a bounce from its July 15 lows because a lot of money is on the sidelines and many people are hoping to time the bottom.

On the other hand, Mendelsohn says that the rapid removal of any more firms could cause the floor to crumble beneath the market. "The longer the process takes, the more probability you have that you can shore up the CMO market. I would rather walk down a flight of steps under control than fall off the landing. Lehman failing here doesn't accomplish that."