The New Toxic Asset Plan

Tuesday, March 24, 2009

Yesterday, we finally got some clarity on the Treasury’s toxic asset plan and the market appeared to like it – but the devil is in the details.  I am going to attempt to simplify it – for my readers as well as for myself!!

So, let’s start with an overview of what has been clogging the credit markets:  the biggest problem has been the legacy (toxic) assets which are complicated parts of home mortgages - many of which have gone bad, and many more of which are likely to go bad in the near future. For simplicty, suppose a bank has $100 million (face value) of these assets on its books.  But due to the increased bad debts associated with these assets and mark to market accounting, the banks have had to mark the assets down to $80 million, and in the process have had to take huge losses (in this case $20 million). Most of the banks would like to get these assets off its books, but claim there is no market for them or in other words that there is a liquidity issue.

In reality it might not be a liquidity issue since there are people out there who might be willing to buy those assets for say $10 million. That, however, would require the bank to write-off an additional $70 million and if it did so, it would be bankrupt. However, let’s just say this bank is in the class that has been deemed “too big to fail.”  So in comes the NEW PLAN.

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