Sunday, May 18, 2008

Where Are the Rest of the Mortgage Losses?

Losses from the mortgage crisis have been estimated at $1 trillion or more. To date, banks and brokerage firms have written off around $330 billion in losses. So there seem to be about $700 billion or so in losses that could still be lurking around. Last week, the Fed's Chairman Bernanke urged banks to raise more capital. While banks and brokerage firms have raised about $244 billion in capital since last summer, they apparently haven't done enough for the Chairman's liking. The fact that some banks continue to pay dividends while needing more capital wouldn't endear them to the regulators. Nor should it endear them to taxpayers, who would foot the bill for further Bear Stearns-style bailouts.

Some of the $700 billion in remaining losses may have been incurred by hedge funds, which usually don't disclose their financial results. Perhaps other losses are being batted back and forth between mortgage holders, mortgage insurers, bond holders, bond insurers, CDO holders, and credit derivatives issuers. As long as each player in this game of musical chairs believes that it has a chair, it may be reluctant to book losses.

Perhaps yet more of the losses are caught up in discussions among firms, auditors and regulators concerning proper accounting treatment, and will be booked when people run out of arguments. Given how cheap talk is, people have every incentive to keep talking instead of facing up to bad news.

It's also possible that the recent easing of the credit crunch has enhanced some asset values. But the continued slowdown in the housing market and the economy as a whole would limit the potential for such enhancement, and may even reverse it. This is a time to be cautious about counting eggs; count chickens for a reality check.

As we know from the last nine months of financial markets uproar, losses cannot be made to go away. They often can't even be effectively shifted by derivatives contracts or other financial sorcery. Once they arise, they have to land somewhere, and someone has take the pain they cause. The remaining losses can't stay out of view forever. Chairman Bernanke didn't urge banks to raise more capital just for the heck of it. Chances are he knows something.

If you're an investor, don't get too aggressive. Stay diversified and cautious. If you're involved in politics, understand that the losses will give the Democrats more ammo. If you're a consumer, build up cash reserves and reduce debt. If you're in the workforce, keep your resume up-to-date and ready to go. And if you're a regulator, try to be prepared this time.

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