Toxic Assets Detoxed

To your bank, toxic assets can be bundled with other loans to form the basis of a ‘mortgage backed security’, a piece of paper, to be sold off to some investor

TR Vivek | 09 Jun, 2009

Toxic assets are neither industrial ruins nor faulty silicon breasts. They are, sadly, homes. Or worse, dull scraps of paper called derivatives

Toxic assets are neither industrial ruins nor faulty silicon breasts. They are, sadly, homes. Or worse, dull scraps of paper called derivatives that get their value from houses. Say, you buy a $1 million house on a $1 million loan at 6 per cent interest. To your bank, it’s an asset, and it can be bundled with other loans to form the basis of a ‘mortgage backed security’, a piece of paper, to be sold off to some investor. But if the rate rises and your house price halves, you’re better off not paying your loan back; let the bank salvage its ‘bad asset’ by reclaiming your house and reselling it.

Now, a few bad assets are okay. Millions spell crisis. America’s toxic assets were the wreckage left behind by the 2007 bursting of a housing bubble inflated by supercheap loans. As millions rushed to buy houses, their prices zoomed. Loans were given out to all and sundry with no downpayment (including Ninja or no-income-job-or-assets homemakers) because bankers were having a blast. The central bank was releasing funds at superlow rates, and all the other bankers were grooving to this music on the assumption that they could pass their default risks on to investors who’d happily buy dull scraps of paper which could be resold to a greater fool (ah, the joys of a market boom).

Then the music stopped, and our merry bankers were left without chairs, as former Citibank CEO Chuck Prince rued before being ejected from his job. Interest rates rose, homeowners couldn’t pay back, homes were vacated, prices tumbled, and properties that fell below the mortgage amounts were abandoned, worsening the crisis. As loan repayments stopped, those dull scraps of paper lost their buyers, turned toxic and devastated bank finances. Billions were lost, with billions more left to be faced up to.

Wall Street investors, the guys who bought all the paper, were hit hardest. Today, some $2 trillion of toxic assets are still lurking around. Can the Obama administration’s new plan of a private-public partnership to buy $1 trillion worth of these rotten assets detox the system? Everyone watches with bated breath.