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Why suddenly banks in liquidity crisis?

As I understand, the foreclosure of millions of homes cause the banks to suffer liquidity crisis (no money to lend). But why? Just because millions of people suddenly could not pay their mortage the banks now have run out of money? How much total aggregate money from these foreclosure homes each month that should go to these banks? I think there could be something else which I do not understand the mechanism of, that cause banks in the US and Europe suddenly in liquidity crisis.

Public Comments

1. Because in order to prevent repeats of companies like Enron, politicians and bureaucrats got their pointy little heads together and came up with an accounting scheme called Mark to Market. The scheme forces the banks to value their debt in a way that ate up their capital faster than Michael Moore in a Cuban Hospital Cafeteria. BTW, it wasn't sudden. Bush warned congress 17 times that Fannie and Freddie had to be reformed or we were in for bad times. The recipients of their ill gotten gains blocked any reform what so ever. If anyone disputes my words, the hearings with Maxine Walters and Barney Frank doing exactly that are readily available.
2. Mortgages are packaged into pools called Collaterized Debt Obligations. Insurance is sold on these CDOs, called Credit Default Swaps (CDS). Total CDS market is $44T. Total CDO market is something like $4T. AIG was huge in the CDS market, but their coverage was leveraged at over 40:1 ($1B trying to cover $40B in CDOs). Lehman Bros was also leveraged at 40:1. Problem - as sub-prime mortgages ran into troubles, the CDOs based on those mortgages declined in value (oversimplified - there were always multiple tranches per loan pool, based on credit-worthiness, so lowest tranches had very high default rates). CDO tranch declines in value so CDS has to payoff, reducing capital. Problem, no one knows how bad the sub-prime market is going to be, and investors world-wide (mostly institutions) carry CDOs on the books as assets. As the assets decline in value, bank needs to raise capital. But, because of the mark-to-market accounting rule, institutions have to reduce the value of the CDOs on their books as their values decline, even if they plan to hold to maturity. As those values decline, banks need to raise more capital to meet capitalization rules. But, investors do not know how bad the mortgage mess is, so don't want to invest in banks that have exposure. Banks are not willing to loan to each other, either, since they don't know who is in trouble.