John Mauldin at Minyanville thinks that the credit crunch will take years to resolve and cost more than $1.6 trillion. The remaining threat, he says, doesn’t come from subprime, but rather from prime and Alt-A loans:
Better than 90% of the losses from subprime assets that are on the books have already been written off. That is good. But Bridgewater [Associates] estimates that there are losses lurking in the prime and Alt-A loan portfolios that could be much bigger than the subprime problems, as those loan books are more than six times the size of the subprime… The bottom line is that they estimate there is at least another $1.1 trillion of losses that will have to be written off by institutions all over the developed world, including very large potential write-offs from insurance companies.
Mauldin believes that the banks and their regulators are aware of how epic these loan losses will be, but are waiting to take writeoffs until the storm has passed and the writeoffs won’t force them to raise capital at horrifically dilutive prices. Mauldin compares the current situation to the Latin American debt crisis of the 80’s. Had U.S. banks been forced to mark their Latin American loans to fair market value immediately, the entire banking system would have collapsed. Instead, regulators and bankers worked together to skirt the rules:
Instead, with a wink and nod, they let them keep the bad bonds on their books at face value, which they all did. Then in the latter part of the decade, starting with Citibank in 1986 (cue the irony), they began one by one to write off the bad loans, but only when they had enough capital to do so. It took six years (or more) of profits and capital raising to get to where they could deal with the problems without imploding themselves and the economy of the US at the same time.
Banks and their regulators face a similar crisis today, and Mauldin thinks it will take years for all the losses to unwind. In the meantime, as credit becomes increasing scarce, the economy will continue to suffer.
Graph: The Federal Reserve Board