Capital in the Financial Crisis
with Timothy F. Geithner and Andrew Metrick, October 2020.
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, mark-to-market losses implied $800 billion of credit losses remaining, and consensus estimates stood at $340 billion. But, the stress test in May 2009 required banks to raise only an incremental $75 billion of capital. Why? First, credit losses are not equivalent to capital needs because banks that remain a going concern can offset losses with revenues. Second, net income and actuarial loss estimates — rather than market-implied losses — were the proper basis for the stress test estimates of capital needs. Finally, the expected path of the economy improved with the macroeconomic policy actions. Covid-19 presents the first significant test of the reforms to bank capital and the structure of the U.S. financial system. Policymakers in some countries will confront similar choices and trade-offs to restore confidence in the financial system’s capital position as they face the second systemic financial crisis in little over a decade. They will undoubtedly see parallels with the 2009 experience.