Page 510 - untitled

Peter J. Wallison 481

56
total assets of $4 trillion. If we assume that the banks had a leverage ratio of about
15-to-1 in 2008 and the investment banks about 30-to-1, that would mean that the
equity capital position of the banking industry as a whole would be about $650
billion and the same number for the investment banks would be about $130 billion,
for a total of $780 billion. Under these circumstances, the collapse of the PMBS
market alone reduced the capital positions of U.S. banks and investment banks by
approximately 41 percent on a mark-to-market basis. Th is does not mean that any
actual losses were suff ered, only that the assets concerned might have to be written
down or could not be sold for the price at which they were previously carried on the
fi rm’s balance sheet.
In addition, Roubini and Parisi-Capone estimated that U.S. commercial
and investment banks suff ered a further mark-to-market loss of $225 billion on
57
unsecuritized subprime and Alt-A mortgages. Th ey also estimated that mark-to-
market losses for fi nancial institutions outside the U.S. would be about 40 percent
of U.S. losses, so there was likely to be a major eff ect on banks and other fi nancial
institutions around the world—depending, of course, on their capital position at the
time the PMBS market stopped functioning. I am not aware of any data showing the
mark-to-market eff ect of the collapse of the PMBS market on other U.S. fi nancial
institutions, but it can be assumed that they also suff ered similar losses in proportion
to their holdings of PMBS.
Losses of this magnitude would certainly be enough—when combined
with other losses on securities and loans not related to mortgages—to call into
question the stability of a large number of banks, investment banks and other
fi nancial institutions in the U.S. and around the world. However, there was one
other factor that exacerbated the adverse eff ect of the loss of a market for PMBS.
Although accounting rules did not require all PMBS to be written down, investors
and counterparties did not know which fi nancial institutions were holding the
weakest assets and how much of their assets would have to be written down over
time. Whatever that amount, it would reduce their capital positions at a time when
investors and counterparties were anxious about their stability. Th is was the balance
sheet eff ect that was the third element of Chairman Bair’s summary.
To summarize, then, the following are the steps through which the
government’s housing policies transmitted losses—through PMBS—to the largest
fi nancial institutions: (i) the 19 million NTMs acquired or guaranteed by the
Agencies were major contributors to the growth of the bubble and its extension
in time; (ii) the growth of the bubble suppressed the losses that would ordinarily
have brought the development of NTM-backed PMBS to a halt; (ii) competition
for NTMs drove subprime lenders further out the risk curve to fi nd high-yielding
mortgages to securitize, especially when these loans did not appear to be producing
losses commensurate with their risk; (iv) when the bubble fi nally burst, the
unprecedented number of delinquencies and defaults among all NTMs—the great
majority of which were held or guaranteed by the Agencies—caused investors to

56 Timothy F. Geithner, “Reducing Systemic Risk in a Dynamic Financial System,” Remarks at the
Economic Club of New York, June 9, 2008, available at http://www.ny.frb.org/newsevents/speeches/2008/
tfg080609.html.
57 Nouriel Roubini and Elisa Parisi-Carbone, “Total $3.6 Trillion Projected Loan and Securities
Losses,” p.7.