Under the Basel Accord for every $100 of AAA securitized assets, a bank need only hold $0.60 of equity, to back up that debt. The theory is AAA assets are among the highest rated and thus the risk of default is virtually nil. However, for every BBB securitized asset, a bank would have to hold almost $5.00 of equity for every $100.
Gold: The Collapse of the Vanities
In other words, if a AAA-rated security is downgraded to BBB, the bank will have post up almost 10 TIMES MORE CAPITAL.
Where are they going to get that capital from at that point?
Are they going to sell the security?
I don't think so--there will be NO BID.
Bernard
The blog's author, Hellasious, responded thus:
Bernard,
You have hit upon a very important element in the whole MBS/ABS situation. While AAA paper won't be downgraded to BBB in one step, the combination of a series of consecutive downgrades and SIV assets going back onto balance sheets (and thus having to be covered by equity) means that the process of painful adjustment will take a long time. In other words, the credit crunch will last.
THIS IS NOT a replay of LTCM, for the simple reason that in its case the banks saved LTCM, so as not to get hurt themselves from the fallout. Today it is the banks/brokers that are in trouble: who's going to save THEM?
Or, to look at it another way: Who will save us from them?
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