"Toxic Assets" - We Like our Euphemisms, eh?
So WHAT'S a "Toxic Asset" - I am asked.
Basically: toxic, being poisonous, would be an asset that will bring down a company or basically bankrupt the company.
The issue is that the asset (for banks their loans) are "non-performing" - meaning the interest (and principal, perhaps) of the loan has not been paid for three months or more, usually. (Banks usually allow some leeway in repayment of debt, mortgages especially, though not always true.)
Once the asset is considered non-performing, it must be moved off the balance sheet and an equal amount of bank capital must be taken from the Liability side of the balance sheet (to an account called "Loan Loss Reserves"). Bank capital is the stockholder's equity. So if a $1 million mortgage is non-performing and moved off the balance sheet, the owners just lost $1 million in total stock value. Therefore, the stock's price must also reflect the loss in value of the company (or even more, if perception is that the company has more of these assets).
Now you can perhaps see that if too many loans are non-performing - the company goes bankrupt.
OK - now to Mortgage Back Securities (MBS) and Collateralized Debt Obligations (CDO) ...
The "market" is valuing these assets at 20 to 40 cents on the dollar (if any value). The banks value them at 60 cents per dollar.
If the banks sell at less than 60 cents, then they will have NO equity (NO Bank Capital) left. Therefore, the MBS and CDOs are toxic assets because the bank cannot sell them and cannot write them off to Loan Loss Reserves or the bank will go bankrupt!
Basically: toxic, being poisonous, would be an asset that will bring down a company or basically bankrupt the company.
The issue is that the asset (for banks their loans) are "non-performing" - meaning the interest (and principal, perhaps) of the loan has not been paid for three months or more, usually. (Banks usually allow some leeway in repayment of debt, mortgages especially, though not always true.)
Once the asset is considered non-performing, it must be moved off the balance sheet and an equal amount of bank capital must be taken from the Liability side of the balance sheet (to an account called "Loan Loss Reserves"). Bank capital is the stockholder's equity. So if a $1 million mortgage is non-performing and moved off the balance sheet, the owners just lost $1 million in total stock value. Therefore, the stock's price must also reflect the loss in value of the company (or even more, if perception is that the company has more of these assets).
Now you can perhaps see that if too many loans are non-performing - the company goes bankrupt.
OK - now to Mortgage Back Securities (MBS) and Collateralized Debt Obligations (CDO) ...
The "market" is valuing these assets at 20 to 40 cents on the dollar (if any value). The banks value them at 60 cents per dollar.
If the banks sell at less than 60 cents, then they will have NO equity (NO Bank Capital) left. Therefore, the MBS and CDOs are toxic assets because the bank cannot sell them and cannot write them off to Loan Loss Reserves or the bank will go bankrupt!
Thanks, Andrew that almost clears it up :-)
In my world we would call that a liability but I guess they're doing everything they can to avoid that term. Toxic asset is such an oxymoron, they need to come up with something better. I'm going down to Borders today to find Economics for Dummies.
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