One might wonder, then, how it was possible that the financial crisis involved banks at all, since they were transferring all of the risk associated with securitization transactions. To clarify this point, recall that, even if the original aim of securitization was to transfer risk from banks to outside investors, it ended up concentrating risk in the bank industry. This concentration of risk occurred because originators/sponsors maintained a good part of the risk related to the SPEs’ assets because they withheld the most junior tranches of ABSs, in order to signal the higher quality of the loans securitized. Moreover, banks had both contractual and reputational obligations toward SPEs, according to which the originator/sponsor had to use its own capital to help the SPE in case of difficulty. The concentration of risk in banks also occurred because banks were used to keeping on their balance sheets other securities linked to securitization transactions, such as highly rated ABS with a liquid market. Investing in AAA tranches ensured high returns compared to their (apparently) low risk and became appealing
investments for the bank that had generated the financial instruments. Unfortunately, because of the poor communication among the bank’s businessunits, the fact that the bank was both the originator and the investor in the securitization process did not help to align interests. In fact, the lack of transparency and communication resulted in some ABS generatedby one
business unit of a bank being acquired by another business unit of the same bank, thus giving financial institutions only the illusion of transferring outside the risk, while they were actually retaining most of it. Table 2, PanelA, reports the amount of losses due to the subprime crisis as o August 2008 for the main banks involved in the collapse of the subprime market. The table also reports the capital raised in response to these losses. Table 2, Panel B, focuses on the US market and reports estimates of losses on unsecuritized loans, as well as, estimates of mark-to-market losses on related securities. Fig. 3, instead, focuses on US Bank Holding Companies and shows the evolution over time of total charge-offs on loans and securitized assets. Taken together, these figures give an idea of the consequences of the subprime crisis on banks’ financial statements.