Meltdown 101: What are Toxic Assets?

By: Marcy Gordon AP
By: Marcy Gordon AP

WASHINGTON (AP) - A fresh effort to end the paralysis in lending was launched Monday by the Obama administration, which will join with investors to buy up around $500 billion in soured assets from banks.

But what exactly are these toxic assets the government wants to get off the banks' books - and how did they get to be poisonous?

Here are some questions and answers about the holdings that are at he heart of the financial crisis and that now figure in the government's solution.

Q: Toxic assets? Sounds dangerous. And they sound more like liabilities than assets. What are they, and how many are there?

A: Toxic assets are, mostly, the investments backed by risky subprime mortgages that are held by the larger U.S. banks and that have lost value. They hang like shackles from the banks' feet, dragging down their balance sheets and their fortunes.

It started in early 2007, when the mortgage crisis hit and defaults on subprime home loans, those made to borrowers with tarnished credit histories, began to climb. That gutted the value of the mortgage-backed securities - subprime mortgages bundled together and sold on Wall Street to investors - held on the books of the big banks.

When the banks - like Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. - started writing down the value of the securities, they reported billions of dollars of losses. Their capital eroded and they didn't have the money to make loans. Credit dried up. Banks large and small foundered and failed. The crisis was in full throttle.

There now are an estimated $2 trillion in bad assets on banks' books.

Q: So how will the new plan for getting toxic assets off banks' balance sheets work?

A: It's what the government calls a public-private investment partnership, with the goal of scooping up about $500 billion, and eventually $1 trillion, in toxic assets. The government will put in $75 billion to $100 billion taken from its $700 billion financial bailout program.

For every $100 in bad assets being purchased, private investors would put up $7, to be matched by $7 from the government. The remaining $86 would be covered by a government loan, provided in many cases by the Federal Deposit Insurance Corp. - the same folks
who provide insurance to make sure depositors don't lose all their money when a bank fails.

Q: Right. So why is this plan just now coming out?

A: When the financial crisis raged in September, the Bush administration first looked to have the government buy up hundreds of billions of dollars in banks' toxic assets. That raised prickly questions of how to price them. They are complex and no one, not even the banks themselves, truly knows how much they are worth.

Considering them radioactive, investors were loath to touch the assets -although they could fetch higher prices in the future after the housing market recovers.

If the government paid too little for the assets - that is, close to recent sales prices of only a few cents on the dollar - it could potentially wipe out the net worth of many banks and set off a wave of bank failures. On the other hand, if Uncle Sam paid too much, he could risk costing taxpayers hundreds of billions of dollars that they wouldn't likely get back.

Another problem: With the markets tumbling lower, there just wasn't enough time to figure out how to price the assets.

So the Bush officials abandoned the idea. Instead, they opted to use hundreds of billions in rescue funds mostly to directly inject capital into banks to get them to lend again.

Now we're back to buying up toxic assets. The idea behind the Obama plan is that private investors would help jump-start a robust market for the securities, potentially lifting their value because they could be sold - and establishing a logical price for them.

Q: Don't banks have to periodically disclose estimates of how they are valuing these assets? So then, how can people say it's hard to figure out their price?

A: That's right, banks have to peg the value of their assets every quarter.

In another twist, the Financial Accounting Standards Board - under prodding from Congress - last week proposed easing requirements for valuing assets under the so-called mark-to-market accounting rules. Those rules require banks to value assets at current prices. The leeway proposed by the standard-setting board would allow them to be valued at what they would go for in an "orderly" sale, as opposed to a forced or distressed sale.

You see, the official value of these assets has become very low because current market conditions would make it hard to fetch much
for them. The theory is that they'd be worth a higher and more realistic price if sold in a more orderly, less "forced" manner.

The board could formally adopt the new standards early next month, putting them in force for the second quarter.

Q: Are there other toxic assets, besides mortgage-linked securities, that are involved here?

A: The main focus for the new program is on assets tied to residential and commercial mortgages.

But the Treasury Department said that could evolve, based on market demand, to embrace other types of assets. That could include securities backed by credit card debt, student loans or auto loans, which have suffered in recent months from rising defaults and have been aided by lending from the Federal Reserve.

Q: How did these things come to be called toxic assets, anyway?

A: The precise origin of the phrase is somewhat shrouded in mystery, though it seems to have come into usage not long ago, in mid-2007. It may have been a Wall Street analyst who first used the phrase, observers say. It caught on, big time. Before that, from the savings and loan crisis two decades ago up through the 2007 meltdown, they were called bad assets or troubled assets, but not toxic.

President Obama avoided using the "T" word in his statement Monday on the new plan. He called them "bad" assets. But the administration's new code phrase for them, used by the Treasury Department, is "legacy assets." Suppose that's because they've been around so long - and besides, it sounds a lot less noxious.


Comments are posted from viewers like you and do not always reflect the views of this station.
powered by Disqus
KOLO-TV 4850 Ampere Drive Reno, NV 89502
Gray Television, Inc. - Copyright © 2002-2014 - Designed by Gray Digital Media - Powered by Clickability 41708957 - kolotv.com/a?a=41708957