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Banks used fancy computer models and mathematical
equations to come up with the answer

What is a bundle of mortgages worth when nobody is willing to bid on them at auction?
With American banks already in trouble,
an Australian bank made matters worse—by telling the truth!
Robert Morley, theTrumpet.com, August 12, 2008

July 25 was a particularly bad day for Australia’s four biggest banking stocks. In a matter of hours, $16.2 billion in stockholder value was erased from existence—the worst fall since Black Monday in October 1987.

Investors jumped ship following the decision by the National Australia Bank to take a 90 percent write-down on a chunk of mortgage-backed assets that were supposedly aaa-rated. Yet, the full implications of the announcement were largely missed by the media. To them, July 25 was just one more bad day in a bad year in which Australian financial stocks ground lower and lower.

The “aaa” assets in question were bundles of U.S. mortgages that National Australia Bank (nab) had purchased for around $1.2 billion prior to the U.S. real-estate and lending bubble bust. The problem with the mortgages arose after American home valuations plunged and homeowners began defaulting on their mortgages in record numbers. All of a sudden, the market for mortgage-backed investments dried up, and no one wanted to buy the formerly triple-A-rated securities anymore.

So the accounting question that American banks faced was:
What is a bundle of mortgages worth when nobody is willing to bid on them at auction?
This was an important question because U.S. banks and investors held “trillions” worth of mortgages.

So banks used fancy computer models and mathematical equations to come up with the answer for accounting purposes—typically valuing their mortgage holdings near or somewhat less than what they paid for them. The result was the banks’ balance sheets continued to look strong, even though house prices were plunging and defaults were rising. As long as no one technically knew what the true market value of the mortgage bundles were, no losses need be admitted, and the game could continue.

But now nab has let the cat out of the bag.

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