A banking system loaded down with hundreds of billions of dollars worth of unrecognized bad debt -- Japan in the 1990s? No, it’s the United States today.
And where are American banks hiding their losses? Among other places, in their loan portfolios.
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Banks have written down billions in toxic securities, but many toxic loans are still carried at close to full value. According to data published by the Federal Reserve late last year, banks are carrying $3 trillion of residential real estate loans and $1.7 trillion of commercial real estate loans on their books for a total of $4.7 trillion. Dan Alpert at Westwood Capital thinks as much as a fifth of that total could be uncollectable.
“We know lots of mortgage loans are underwater,” he says, describing the situation where the value of collateral has fallen below the principal balance of a loan. “A majority of the loans banks are holding were originated at the height of the bubble, when securitization broke down.”
When securitization markets were fully functional, banks had been able to package and sell their loans to investors. When those markets buckled, banks were forced to eat their own cooking -- much of it rancid.