Toxic assets are investments that aredifficult or impossible to sell at any price because the demand for them has collapsed. There are no willing buyers for toxic assets because they are widely perceived as a guaranteed wayto lose money.
The term toxic asset was coined during the financial crisis of 2008to describe the collapse of themarket formortgage-backed securities, collateralized debt obligations (CDOs) and credit default swaps (CDS). Vast amounts of these assets sat on the books of various financial institutions. When they became impossible to sell, toxic assets became a real threat to the solvency of the banks and institutions that owned them.
Key Takeaways
Toxic assets are investments that have become worthless because the market for them has collapsed.
Toxic assets earned their name during the 2008 financial crisis when the market for mortgage-backed securities burst along with the housing bubble.
So-called vulture capitalists actually seek out toxic assets that may be undervalued and seek to restore them to profitability.
Toxic assets were originallycalled troubled assets. It took the financial crisis of 2008 to produce a more vivid term. That was when it became clear that some of the biggest U.S. financial institutions were sitting on a vast quantity of worthless assets. In fact, they were losing value at a pace that many had not thought was possible.
This underestimation of the downside risk might have been in part a lack of imagination, but it was exacerbated by a lack of rigor by the ratings firms.
How an Asset Goes Toxic
A toxic asset can best be described through an example. John buys a house and takes out a $400,000 mortgage loan with a 5% interest rate through Bank A. Through the process known as securitization, Bank A turns the loan into a mortgage-backed security and sells it to Bank B. Bank B now owns an income-producing asset: the 5% mortgage interest paid by John. John continues to pay his mortgage because home prices are rising and his mortgage is shrinking. He's building up equity that he can tap into at some future date. Everybody wins.
Then home prices start falling. It turns out John borrowed more than he could afford, and the house is worth less than he owes on it. John defaults on his mortgage. Bank B no longer receives the payments to which it is entitled. The house can be sold at a loss if at all. Bank B's mortgage-backed security has become a toxic asset.
The 2008 financial crisis may be said to have been caused by an underestimation of downside risk combined with a lack of rigor by the ratings firms.
Scale this up by a factor of millions, and you have the story of the mortgage meltdown.
Dealing with Toxic Assets
There isn't a definitive playbook on how to deal with toxic assets but there is one example of a strategy that worked.
In the wake of the 2008 financial crisis, the Troubled Asset Relief Program (TARP) was the U.S. government's solution. It created a legally-mandated and government-sponsored buyer of last resort that took these assets off the books of financial institutions and allowed them to stem the bleeding.
This, along with actions taken by the Federal Reserve to pump money into the system, likely saved the global economy from plunging into a full-out depression rather than a severe recession.
In December 2013, the Treasury wrapped up TARP and the government concluded that its program had earned more than $11 billion for taxpayers. TARP recovered funds totaling $441.7 billion compared to $426.4 billion invested.
The government also claimed credit for preventing the American auto industry from failing and saving more than a million jobs, helping to stabilize banks and restoring credit availability for individuals and businesses.
Who Wants Toxic Assets?
Some professional investors specialize in accumulating toxic assets. They are convinced that the value of these assets is depressed far below the levels that their fundamentals justify.
These so-called vulture investors hope to profit when the fear has subsided and the market for such assets returns.
Toxic assets are investments that have become worthless because the market for them has collapsed. Toxic assets earned their name during the 2008 financial crisis when the market for mortgage-backed securities
mortgage-backed securities
Mortgage-backed securities (MBS) are investment products similar to bonds. Each MBS consists of a bundle of home loans and other real estate debt bought from the banks that issued them.
What is Toxic Debt? The most obvious answer is high interest revolving credit. This could be in the form of a payday loan, credit card, personal loan, etc.
The Troubled Asset Relief Program (TARP) was instituted by the U.S. Treasury following the 2008 financial crisis. TARP stabilized the financial system by having the government buy mortgage-backed securities and bank stocks. From 2008 to 2010, TARP invested $426.4 billion in firms and recouped $441.7 billion in return.
Troubled assets included real estate and mortgage-related assets and securities based on those assets. This included both the mortgages themselves and the various financial instruments created by pooling groups of mortgages into one security to be bought on the market.
A toxic asset can best be described through an example. John buys a house and takes out a $400,000 mortgage loan with a 5% interest rate through Bank A. Through the process known as securitization, Bank A turns the loan into a mortgage-backed security and sells it to Bank B.
Key Points. Good debt—mortgages, student loans, and business loans, steer you toward your goals. Bad debt—credit cards, predatory loans, and any loan used for a depreciating asset—steers you away from your goals.
The Bottom Line. Equities and real estate generally subject investors to more risks than do bonds and money markets. They also provide the chance for better returns, requiring investors to perform a cost-benefit analysis to determine where their money is best held.
Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies in the asset class mix.
Generally, you should consider five broad asset classes when constructing your investment portfolio: cash, fixed-principal investments, debt, equity, and tangibles. Cash refers to the most liquid holdings in your portfolio.
Your money is safe in a bank, even during an economic decline like a recession. Up to $250,000 per depositor, per account ownership category, is protected by the FDIC or NCUA at a federally insured financial institution.
A toxic asset is a financial asset that has fallen in value significantly and for which there is no longer a functioning market. Such assets cannot be sold at a price satisfactory to the holder.
The term toxic asset was coined during the financial crisis of 2008 to describe the collapse of the market for mortgage-backed securities, collateralized debt obligations (CDOs) and credit default swaps (CDS). Vast amounts of these assets sat on the books of various financial institutions.
Illegal assets means assets related to serious crimes including specific crimes and drug related crimes (criminal proceeds, property derived from criminal proceeds and any other property in which either one of the above properties is indistinguishably mixed with other kinds of property).
An asset is anything you own that adds financial value, as opposed to a liability, which is money you owe. Examples of personal assets include: Your home. Other property, such as a rental house or commercial property.
A simple rule about debt is that if it increases your net worth or has future value, it's good debt. If it doesn't do that and you don't have cash to pay for it, it's bad debt.
A bad debt might be recovered through a payment from a bankruptcy trustee or because the debtor has decided to settle the debt at a lower amount. A bad debt may also be recovered if an asset used as collateral is sold. For example, a lender may repossess a car and sell it to pay the outstanding balance on an auto loan.
Debt can be considered “good” if it has the potential to increase your net worth or significantly enhance your life. A student loan may be considered good debt if it helps you on your career track. Bad debt is money borrowed to purchase rapidly depreciating assets or assets for consumption.
Introduction: My name is Carlyn Walter, I am a lively, glamorous, healthy, clean, powerful, calm, combative person who loves writing and wants to share my knowledge and understanding with you.
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