One important element is the importance of the services the firm provides to the broader financial system and the economy and the ease with which customers can move their business to other providers. Another is the extent to which the firm’s structure and activities create the potential for contagion – that is, direct losses for counterparties, fire sales of assets held by other  1  This would presumably require legislation. BIS central bankers’ speeches  1  leveraged financial institutions, or loss of confidence that might precipitate runs on other firms with similar business models. The presence of large negative externalities creates a dilemma for policymakers when such firms are in danger of failing, particularly if the wider financial system is also under stress at the same moment. At that point in time, the expected costs to society of failure are very large compared to the short-run costs from providing the extraordinary liquidity support, capital or other emergency assistance necessary to prevent catastrophic failure. The market’s belief that a TBTF firm is more likely to be rescued in the event of distress than other firms weakens the degree of market discipline exerted by capital providers and counterparties. This reduces the firm’s cost of funds and incents the firm to take more risk than would be the case if there were no prospect of rescue and funding costs were higher.
First, given the length of the foreclosure process, realised losses on the sub-prime mortgages which underpin securities may not total much more than $ billion so far. Second, if projecting forward the rate at which delinquencies are cumulating on recent vintages of subprime mortgages, we can estimate that losses on the securitised loans might ultimately exceed $ billion. Thirdly, using the sub-prime ABX indices to “mark-tomarket” sub-prime securities, can produce figures of $ to 400 billion. Against these figures, international banks have so far announced writedowns (net of hedging) of $ to $ billion. •  Although these are huge numbers, they amount to less than 1% of the total assets of the Large Complex Financial Institutions (LCFIs) in the US and Europe. In relation  2  BIS Review 24/2008  to GDP, even the higher estimates would be comparable to the losses in the Savings and Loans crisis. 2 •  But the securitisation model has not just made it difficult to scale the problem; it has added a large measure of uncertainty and opacity to the distribution of losses and that is a key factor in the continued reluctance to lend and the closure of most ABS markets. The current worries on the future of the monoline bond insurers reflected in their CDS prices in Chart 6 are exacerbating the uncertainties about individual banks’ exposures. The third factor is the dislocation of the investor base for ABS. Since the summer many of the main buyers of ABS have withdrawn from the market.