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What are toxic assets, and how will Obama plan work?
Hope is that private investors will revive market for securities
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Published: March 24, 2009
WASHINGTON
A fresh effort to end the paralysis in lending was announced yesterday by the Obama administration, which will join with investors to buy up about $500 billion in soured assets from banks.
But what are these assets that the government wants to get off the banks' books -- and how did they get to be toxic?
Here are some questions and answers about the holdings that are at the 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 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 began and defaults on subprime home loans -- those made to borrowers with poor credit histories -- began to rise. 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 -- 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 did not have the money to make loans. Credit dried up. Banks large and small foundered and failed. The crisis was at 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 is 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 agency that provides insurance to make sure that depositors do not 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 at having the government buy up hundreds of billions of dollars in banks' toxic assets. That raised prickly questions about how to price them. They are complex, and no one, not even the banks, truly knows how much they are worth.
Considering them radioactive, investors were loath to touch the assets -- although they could bring higher prices 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 the government paid too much, it could risk costing taxpayers hundreds of billions of dollars that they would probably not get back.
Another problem: As the markets fell lower, there just was not enough time to figure out how to price the assets.
So the Bush officials abandoned the idea. Instead, they chose to use hundreds of billions in rescue money mostly to directly inject capital into banks to get them to lend again.
Now we are back to buying up toxic assets. The idea behind the Obama plan is that private investors would help revive a market for the securities, potentially increasing 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 that it is 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 -- proposed last week 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.
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 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.
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