The current consensus is that while U.S. banks are hopelessly riddled with mortgage junk, crafty foreign banks have more or less escaped the asset-backed peril. Is that right? Maybe not.

The Federal Reserve has released a paper that discusses foreign exposure to assets backed by U.S. mortgages. The conclusion is that the Fed has no idea how much foreign banks will lose on their US real-estate bets, except that it will be a lot:

we predict that foreigners would ultimately lose $75 billion on their holdings of ABS backed by U.S. assets...

Then again, the mark-to-market losses stemming from a price markdown in all foreign-held ABS can be as much as six times larger using a 20 percent price markdown.

$450 billion?! Holy gargantuan write-down, Batman! But how can a relatively modest increase in the markdown rate produce such a huge difference in losses?

When potential buyers are unsure of the composition of assets underlying the securities and unsure about what parts of the chain will bear the losses, their uncertainty brings down prices as if each security in a repackaging chain contained bad collateral and would bear the loss. The illiquidity

caused by this uncertainty induces further downward pressure on prices.