Capital in the Financial Crisis
with Timothy F. Geithner and Andrew Metrick, December 2019.
Why was the financial system stabilized with so little additional capital and very little additional public capital by mid-2009 despite substantial loss estimates? In early 2009 consensus estimates of credit losses remaining for the U.S. banking system stood at $340 billion, and mark-to-market implied losses of $800 billion painted an even bleaker view. Compared to $340 billion of Tier 1 common capital — the highest quality loss-absorbing capital — implied losses in the banking system were sufficiently large to leave the system nearly insolvent. Despite large loss estimates, the stress test in May 2009 required banks to only raise an incremental $75 billion of capital. We highlight three reasons. First, credit losses are not equivalent to capital needs because banks offset losses with revenues. Second, the stress tests used actuarial loss estimates rather than market-implied losses. Finally, the macro context improved markedly in the first half of 2009. We discuss the reality that both policy choices and good luck played roles in returning confidence to the financial system in 2009.