Wednesday, February 27, 2008

Bank credit and the monoline

Felix Salmon looks at the way that monoline downgrade will add to the pressure to rebuild capital.
But what Dizard doesn't mention is that a lot of the looming problem comes not from marking to market, but rather from rules which have meant banks not having to mark to market. I'm talking about all those securities on banks' balance sheets which are rated triple-A thanks to a now-worthless monoline wrap. Since triple-A securities have a zero risk weighting for capital adequacy purposes, banks have to put aside zero capital against them. The minute the monolines get downgraded, the banks suddenly have to mark these highly illiquid bonds to market. The banks then take two simultaneous capital hits: the first because the bonds aren't zero risk-weighted any more and therefore need capital to be held against them, and the second because of the write-downs on the mark-to-market losses.

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