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The 2008 financial crisis exposed numerous flaws in America’s financial system, such as the inherent danger of America’s largest banks being overleveraged. Significant dangers remain despite a slate of reforms designed to keep banks on sound financial footing going forward. A recent article in Cryptopolitan magazine revealed that American banks’ potential loss exposure on real estate-related securities skyrocketed to $750 billion in Q3 2024.
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This is raising concerns for many reasons. First, the estimated $750 billion is roughly seven times more than banks held in 2008. Second, many unrealized losses are concentrated in portfolios that are crucial to bank profits. The most at-risk portfolios are:
· AFS-Available for sale
· HTM-Held to maturity
One deeply troubling aspect of the potential $750 billion in losses is that so much is tied to residential mortgage-backed securities (RMBS). Banks loaded up on these when interest rates were lower. The easy credit made it easier for banks to acquire larger debt tranches and the underlying assets were also easier to sell. Making such heavy investments in RMBS now threatens to boomerang back on banks and investors in a big way.
Many of those HTM portfolio loans are approaching maturity dates and high interest rates are slowing sales down in the AFS portfolios. That’s why the potential losses are beginning to stack up. Increased financing costs are consuming massive chunks of what used to be profit and Investors are wary of buying RMBS in the current environment.
This decreases the value of bank-held RMBS while increasing the potential losses on the underlying assets. Being upside down on large AFS or HTM portfolios has taken banks down. In 2023, unrealized losses on First Republic Bank’s commercial loan portfolios were a major contributor to the bank’s eventual collapse and takeover by JP Morgan Chase.
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Banks may have been able to carry these balances in years past, but one of the major reforms instituted after 2008 is making that much more difficult. U.S. banks must submit to periodic “stress tests” where their liquidity is weighed against outstanding debt and liabilities. If those numbers are out of line, the bank could be forced to close or make major markdowns.
