Web Extra: Read an Excerpt of David Stockman's New Book

WHY THE MAIN STREET BANKS WERE MONEY GOOD The commercial banks had retained on their own balance sheets about $2 trillion of residential mortgages and home equity lines of credit. But these mortgages were overwhelmingly of prime credit quality and had stayed on the books as "whole loans," rather than having been sliced and diced into tradable securities. So as the economy tumbled into recession and average home prices plunged by 35 percent, any elevation of losses would be charged to loan loss reserves and written off over years, not sold at fire-sale prices on Wall Street's crashing market for securitized paper. The commercial banking system was not vulnerable to a panic, just a slow multi-year resolution.

In short, the GSE securities plus the whole mortgage loans added up to $3.2 trillion in housing assets, but the Freddie–Fannie (GSE) paper was money good and the whole loans were higher quality and were backed by substantial loan loss reserves required by regulators. So the Main Street commercial banking system was surprisingly well insulated from the putative financial "contagion" on Wall Street.

Much the same can be said for the remaining $6 trillion of non-home mortgage assets which sat on commercial bank balance sheets at the time of the crisis. About $1.6 trillion of this was low-risk revolving and term credit to business and industry known as "C&I (commercial and industrial) loans."

Most of these business loans occupied the senior slot, or the highest payment ranking, in borrower capital structures and usually had a first lien on the operating assets of the borrower's business. So the risk of loss was modest, and the prospect of a C&I loan meltdown was essentially nonexistent. In fact, the truly risky business credit, $1.5 trillion of then-outstanding unsecured and subordinated debt, was all in junk bonds, and nearly all of these were owned by institutional investors and mutual funds, not banks.

The story was much the same in the case of the commercial real estate loan books of the Main Street banks; that is, loans on office buildings, strip malls, retail properties, and housing land acquisition and development. Once again, nearly half of the $3 trillion in outstanding commercial real estate debt had been sold to Wall Street, where it had been securitized and packaged into commercial mortgage-backed securities (CMBSs). By the time of the crisis, these hot potatoes were languishing unsold on Wall Street balance sheets or stuffed into the portfolios of pension funds and insurance companies, but they were no longer in the loan books of the Main Street banking system.

The commercial banking system had retained about $1.7 trillion of whole loans in the various commercial real estate categories, but there was little risk of a selling contagion. Most of these loans were "interest only" with a five- to ten-year bullet maturity, meaning that it would take years for borrowers to run out of cash and default on interest payments when failed strip malls and unfinished subdivisions eventually became foreclosures. That prospective slow bleed-off was irrelevant to the bonfires which raged on Wall Street in September 2008.

Indeed, busted commercial real estate loans have accounted for most of the five hundred bank closures conducted by the FDIC in the years since the crisis. Yet all of these shutdowns were orchestrated over weekends with such clockwork precision that hardly a single retail depositor anywhere in the nation was ever alarmed. Unlike Wall Street's hot money funding, Main Street loan portfolios were bedded down with high-persistency deposits. Losses would be realized over time through the bleeding cure, not a fire sale.

The remaining $2 trillion of assets on the commercial banking systems balance sheet as of October 2008 were not even remotely exposed to contagion risk. About $1 trillion of this total consisted of credit card, auto, and other consumer loans that were well secured with collateral and provisioned with deep loss reserves. The other $1 trillion consisted overwhelmingly of US Treasury securities and investment grade corporate bonds.

Join the Discussion
blog comments powered by Disqus
You Might Also Like...