What Are Toxic Assets?

Daily Herald (Arlington Heights, IL), March 24, 2009 | Go to article overview

What Are Toxic Assets?


Byline: Marcy Gordon Associated Press

WASHINGTON u 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 banksAE books u and how did they get to be poisonous?

Here are some questions and answers about the holdings that are at the heart of the financial crisis and that now figure in the governmentAEs 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 banksAE 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 u subprime mortgages bundled together and sold on Wall Street to investors u held on the books of the big banks.

When the banks u like Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. u started writing down the value of the securities, they reported billions of dollars of losses. Their capital eroded and they didnAEt 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 banksAE books.

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

A: ItAEs 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. u the same folks who provide insurance to make sure depositors donAEt 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 banksAE 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 u although they could fetch higher prices in the future after the housing market recovers.

If the government paid too little for the assets u that is, close to recent sales prices of only a few cents on the dollar u it could potentially wipe out the net worth of many banks and set off a wave of bank failures. …

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