Bank Accounting Question

Dear People Who Actually Understand Accounting:
Joe Plumber takes out a mortgage on a \$1,000,000 dollar house, 20% down, 7% interest. Mortgage company A sells it to him, taking in
\$200,000 and a note for \$800,000. Mortgage co. A packages Joe's mortgage with 10 other similar mortgages, total \$8,000,000 face value note @ 7% and that's called a CDO. Bank A floats \$7,000,000 of paper @ 5%, puts up \$1,000,000 of its own money, and buys the \$8,000,000 CDO. Mortgage co. A keeps the \$2,000,000 down payments, pockets the \$8,000,000 from Bank A, and happily goes off and builds more houses or writes more mortgages. (I've ignored fees Mortgage co. A charges Joe, and fees it charges Bank A.)
Bank A now has 7 to 1 leverage, and it's books look like this:
CDO Asset \$8,000,000 Cash Decrease (1,000,000) -------- Note due \$7,000,000 Equity \$Y-amount Y
The market for CDO's shifts, mark-to-market accounting comes in, and Bank A now has to write down it's CDO to \$6,000,000, and shows that \$2,000,000 decline in value as a Loss on Investment on its income statement.
Bank A's books now look like this:
CDO Asset \$6,000,000 Cash Decrease (1,000,000) --------- Note due \$7,000,000 Equity \$Y-amount (2,000,000)
I'm not sure I understand how the reserve requirements play into this - obviously it has to have some, and their "Cash" has decreased. But it seems to me that if the bank planned to hold the CDO's to maturity, even with a default rate higher than the usual one or two percent, they would not have to write down the value of the CDO's.
If 10% of the homeowners go into default and the bank forecloses at 50% of the face value of \$1,000,000 of mortgage, then it writes off \$1,000,000 of CDO's, takes \$500,000 cash on sale of houses, and its books look like this:
CDO Asset \$5,000,000 Cash Decrease (1,000,000) Cash from Sale 500,000 --------- Note due \$7,000,000 Equity \$Y-amount (2,500,000)
For Bank A to "de-leverage", it has to find a buyer for the CDO Asset. Supposing it found one, and sold \$3,000,000 of the CDO's, it would look like this:
CDO Asset \$2,000,000 Cash Decrease (1,000,000) Cash Inflow 3,000,000 Cash from Sale 500,000 --------- Note due \$7,000,000 Equity \$Y-amount (2,500,000)
If Bank A then repaid \$2,000,000 of it's paper, it would look like this:
CDO Asset \$2,000,000 Cash X Cash from Sale 500,000 --------- Note due \$5,000,000 Equity \$Y-amount (2,500,000)
And essentially, the bank has shrunk from \$7,000,000 to \$2,500,000. If leverage were higher than 7 to 1, then the bank goes bankrupt not principally because it has no cash to pay its Accounts Payable, but because it has written down the value of its Assets to such a low level that it essentially has none.
Is the above basically correct?
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