Leveraged Losses: Lessons from the Mortgage Market Meltdown

My buddy Paul is off skiing in Aspen, Colorado leaving us worker drones to do the heavy lifting. Ski boy managed to forward me this report: Leveraged Losses: Lessons from the Mortgage Market Meltdown.

The abstract and graphs below are quite compelling:

"This report discusses the implications of the recent financial market turmoil for central banks. We start by characterizing the disruptions in the financial markets and compare these dislocations to previous periods of financial stress. We confirm the conventional view that the current problems in financial markets are concentrated in institutions that have exposure to mortgage securities. We use several methods to estimate the ultimate losses on these securities. Our best (very uncertain) guess is that the losses will total about $400 billion, with about half being borne by leveraged U.S. financial institutions. We then highlight the role of leverage and mark-to-market accounting in propagating this shock. This perspective implies an estimate of the eventual contraction in balance sheets of these institutions, which will include a substantial reduction in credit to businesses and households. We close by exploring the feedback from credit availability to the broader economy and provide new evidence that contractions in financial institutions balance sheets’ cause a reduction in real GDP growth."






UPDATE: February 29, 2:30pm

Just got back from a lunch meeting (bumped into Lindsey from WallStrip on the way back!) and saw the WSJ Real Time Economics post on this:

Banks May Need to Shrink by $2 Trillion on Subprime Losses

Mortgage losses, compounded by contemporary risk management and
accounting practices could prompt banks and other lenders to shrink
their lending and other assets by a staggering $2 trillion, a new study

The resulting withdrawal of credit could knock one to 1.5 percentage
points off economic growth, significantly compounding the impact of
collapsing home construction and softer consumer spending due to lower
home wealth, the study, presented at a joint academic-Wall Street forum
in New York Friday.

The study is one of the most exhaustive efforts to date to pinpoint
the scale and location of mortgage losses and how those losses will
affect economic growth.



Leveraged Losses: Lessons from the Mortgage Market Meltdown
David Greenlaw, Jan Hatzius, Anil K Kashyap, Hyun Song Shin
US Monetary Policy Forum Conference Draft, February 29, 2008

Download usmpf_2008.pdf

Banks May Need to Shrink by $2 Trillion on Subprime Losses
Greg Ip
WSJ Real Time Economics, February 29, 2008, 11:59 am


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