Nov. 30 (Bloomberg) -- Citadel Investment Group LLC's agreement to prop up E*Trade Financial Corp. paints a rather frightening picture of how much the value of bonds backed by mortgages and other types of debt has dropped.

Citadel paid just 27 cents on the dollar to buy $3 billion of asset-backed securities from E*Trade, the third-largest U.S. online brokerage firm by customer assets, in connection with a $2.55 billion investment.

That's the kind of price associated with distressed debt, including bonds of companies that are in bankruptcy or may be headed there soon.

Pope & Talbot Inc.'s 8 3/8 percent bonds due in June 2013, for example, traded at 25.625 cents yesterday, according to the Trace price-reporting service. The wood-products manufacturer sought U.S. bankruptcy court protection on Nov. 19, three weeks after making a similar filing in Canada.

Yet there's a big difference between these bonds and E*Trade's holdings: their creditworthiness, as determined by rating companies. Pope & Talbot, based in Portland, Oregon, was rated CCC by Standard & Poor's and Caa2 by Moody's Investors Service before they dropped coverage about a month ago.

While these levels were near the bottom of the rating scales, the bonds owned by E*Trade had a far higher standing. Fifty-eight percent of the New York-based firm's $3.05 billion in securities were rated AA or higher as of Sept. 30, according to a regulatory filing. Another 40 percent were in the A or BBB range, also investment grade.

Prime Borrowers' Debt

What's more, the filing showed that riskier types of asset- backed securities -- the ones hit hardest by the collapse of the subprime-mortgage market, in other words -- were only 15 percent of the firm's holdings.

E*Trade owned $450 million of asset-backed collateralized debt obligations and second-lien securities, or bonds backed by second mortgages, on Sept. 30. The other $2.6 billion consisted primarily of debt backed by first mortgages to prime borrowers, or home buyers with relatively high credit ratings.

Why, then, would Citadel pay so little? There's a clue in E*Trade's filing: $50 million of asset-backed CDOs that had AAA ratings were reduced to junk-bond status between Oct. 1 and Nov. 7. Another $158 million of debt was downgraded as well.

Citadel, a hedge-fund manager based in Chicago, also was able to drive a hard bargain by buying E*Trade's entire holding for $800 million and agreeing to invest another $1.75 billion in the firm. BlackRock Inc., the largest publicly traded U.S. fund manager, is helping with the latter.

Greater Transparency

Whatever the circumstances, the purchase provides some much-needed transparency for the value of asset-backed bonds. Banks and brokers use a ``mark-to-make believe'' approach to value much of their debt, in the words of Bob Janjuah, chief credit strategist at Royal Bank of Scotland Plc in London.

The 27-cents-on-the-dollar figure had to send shudders through these firms, especially their top executives. If it's any gauge of what their asset-backed debt holdings are really worth, losses on the bonds may be far from over.

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Sears Holdings Corp.'s namesake department-store chain sponsors ``Extreme Makeover: Home Edition,'' broadcast on the ABC television network. The company itself may need an extreme makeover, judging by its third-quarter earnings report.

Sales at Sears and Kmart, the Hoffman Estates, Illinois- based company's other chain, declined 4.6 percent last quarter at stores open for a year or more. They have been dropping ever since Chairman Edward Lampert combined them in March 2005.

Earnings are also slumping. They eroded to almost nothing in the quarter ended Nov. 3. The company's profit of 1 cent a share was 31 cents less than the lowest estimate among seven analysts in a Bloomberg survey.

Sears Holdings can't fix itself just by going after Restoration Hardware Inc., the home-furnishings chain it's seeking to buy for $269 million. Lampert and Chief Executive Officer Aylwin Lewis have to figure out how to revive Sears and Kmart as well. It's much easier said than done.

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The owners of Canadian's largest stock and derivatives exchanges have been flirting with each other for years. Stock investors have now sent the companies an unmistakable message: it's time to get together.

TSX Group Inc., which owns the Toronto Stock Exchange, recorded its biggest stock-market gain in three years after disclosing takeover talks with Montreal Exchange Inc., where futures and options contracts on Canadian stock and bonds are traded. TSX's shares added 5.8 percent in Canadian trading.

Montreal Exchange rose even more: 22 percent, its biggest one-day gain since going public in March. Before yesterday, the stock had fallen 37 percent from its close on the first day of trading. Publicly traded exchanges worldwide, by contrast, are climbing for a fifth straight year.

The earlier slump erased a 69 percent profit for Nymex Holdings Inc. on its 10 percent stake in the Montreal exchange, bought before its trading debut. A TSX-Montreal combination may help Nymex, along with other investors, come out ahead.

(David Wilson is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: David Wilson in New York at dwilson@bloomberg.net

Last Updated: November 30, 2007 00:16 EST