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July 23rd, 2009

Toxic Assets: The Stubborn Stain on Economic Recovery



The term “toxic assets” became a common phrase to the everyday consumer in the later months of 2008. At that time our economy was in a free fall and these toxic assets were in part to blame. In an attempt to right the sinking ship that was our economy, Federal officials decided to create a $700 billion program to rid our financial markets of these toxic assets — mortgages, certain securities, and other loans which have gone bad. Professors and authors Kenneth Scott and John Taylor write in the Wall Street Journal that toxic assets are “one of the original causes of the financial crisis” which “still persists and remains a serious impediment to economic recovery.”


For the most part, the problem has never been properly dealt with. The original purpose of the $700 billion Troubled Asset Relief Program (TARP) was to purchase these bad assets from the banks and investment firms that held them on their books so that they could begin lending again.

But that never happened. The Treasury couldn’t determine the best way to price these troubled assets, so no one bought them. They abandoned their toxic-asset strategy and decided to lend the $700 billion to troubled institutions instead.

The Problem Still Persists

Granted, the TARP money did help some investment banks (and just yesterday the U.S. saw its first return on their investment), but TARP hasn’t done what it originally set out to do — rid banks of these items, so the problem still persists. Realizing that the problem never went away, the Treasury created the Public-Private Investment Program (PPIP):

The concept is that private asset managers would create investment funds of half private and half Treasury (TARP) capital, which would bid on packages of toxic assets that banks offered for sale. The responsibility for valuation is thus shifted to the private sector. But the pricing difficulty remains and this program too may amount to little.

Transparency Is the Only Way

Scott and Taylor believe that the only way to solve the problem of toxic assets is through increased transparency:

We believe their sheer complexity is the core problem and that only increased transparency will unleash the market mechanisms needed to clean them up.

A Complex Problem With a Simpler Solution?

The authors feel that the best way to price toxic assets (hence get rid of the problem), is through a simple, centralized database that would require all issuers of these assets, whether they were sold publicly or privately, to “provide extensive detail in a uniform format about the composition of the original pools and their subsequent structure and performance…”:

By creating a centralized database with this information, the pricing process for the toxic assets becomes possible. Making such a database a reality will restart private securitization markets and will do more for the recovery of the economy than yet another redesign of administrative agency structures. If issuers are not forthcoming, then they should be required to file the information publicly with the SEC.

With the PPIP costing $30 billion, and with some experts claiming that the cost of the TARP is ranging far higher than $700 billion, a database seems like a simple solution to as complicated of an economic problem as we can think of.

Why Not?

If this is the “simpler” solution, why wouldn’t anyone want to participate? If an entity hasn’t lost money, why should they be required to disclose information? This database could reveal competitive information and/or investment strategies. Lastly, knowing the construct of these assets won’t necessarily help provide a valuation, only clarity into the composition of the asset.

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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