What Are Toxic Assets?

The term "toxic assets" is tossed around quite a bit these days, especially now that the Treasury Department has announced plans to buy up U.S. banks' bad assets to the tune of $1 trillion dollars (more on that in a minute). Terms like toxic assets have become common place, like the terms mortgage meltdown, financial crisis and economic stimulus. But does the American public understand what these toxic assets really are?

Let's say you bought a house for $300,000 dollars and Bank A gave you a mortgage for that house for the full $300,000 at 6 percent interest. There was no down payment, so the only collateral the bank has is the house itself. Shortly after the purchase, your house is appraised for $325,000 and the bank's "asset," a.k.a. your house, has increased in value. Bank A packages together several of these seemingly lucrative assets and sells them to Bank B and Wall Street investors in what are called mortgage-backed securities.

Unfortunately, your house is appraised again a year later for only $255,000. Multiply this scenario millions of times and you have what is known as a bank crisis due to the no longer lucrative mortgage-backed securities. The mortgages backing these securities have lost value and thousands of homeowners are defaulting on these mortgage loans. The bank is left holding the bag, or rather the bad debt. These "assets" are no longer valuable and are "toxic" to the bank, corroding the bank's inherent value and compromising its ability to make loans.

There is nothing the banks can do about all these suddenly less valuable loans, even with most homeowners continuing to make payments. Let's say Bank A sold Bank B a bundle of mortgages that were collectively worth $300 million, made up of 1000 loans just like the no-money-down, $300,000. If all of these loans decreased in value by 15 percent, as in the example, the bank is out $4,500,0000. Again, imagine this on a nearly trillion dollar scale.

According to the Minneapolis Star Tribune, "When the banks -- such as 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. An estimated $2 trillion in bad assets are now on banks' books."
Treasury Secretary Timothy Geithner's solution to this huge financial fiasco is called the Public-Private Investment Program. In a letter to the Wall Street Journal, Geithner explained, "The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government."

This apparently made sense to Wall Street and the stock market leaped the day Geithner released the details of his plan. What it boils down to is that the FDIC and the Federal Reserve will make capital available to allow investors to buy up the so called toxic assets, thus getting them off the banks' books. The government will have much greater stake than any private investor. Geithner assures the American public that "the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments."

About the Author
Ki works as a realtor in the Austin real estate market. His website offers a graphical search of the Austin MLS. He also provides information on Austin real estate and Austin commercial real estate.