Remember subprime mortgages? Believe it or not, those things still exist and banks own hundreds of billions of bonds built on them. And, despite the huge write-downs we’ve seen so far, many market watchers believethe banks haven’t aggressively marked down their subprime portfolios.
Moody’s had been estimating losses on subprime bonds from the worst years of the housing bubble and mortgage mania–2005 through 2007–to be just above 20 per cent. It’s 2006 MBS loss estimate was 22 per cent, for instance. The pool of bonds from 2005 to 2007, represents about $680 billion of mortgages. At a 22 per cent loss rate the bond holders were sitting on $149 billion of projected losses from subprime alone.
Today Moody’s finally got around to admitting that those projections were way too optimistic. Now it thinks the losses for 2006 will reach 28 per cent to 32 per cent. It’s undertaking a review of all the MBS from 2005 to 2007. While this is still at the preliminary stage of review, if the 32 per cent number holds that’s an extra $68 billion in losses.
Keep in mind that Moody’s isn’t projecting the market price for these bonds, so complaints about mark to market don’t come into the picture. These percentage reflect what Moody’s will believe will be the actual losses.
Calculated Risk points out that this should have an impact on the stress tests at banks. Unfortunately, the details of the stress tests are still being kept secret so we don’t actually know what loss rates they are assuming in either the likely or adverse scenario. Likewise, we don’t know how far down banks have actually marked their subprime portfolios. Instead, we’re left to wonder: are the supposedly “well capitalised” banks healthy enough to take the losses?