Wednesday, March 11, 2009

If it's an asset, it isn't toxic

Good point, Yglesias:
I’m increasingly frustrated with the conventions in which this idea is discussed in public. I think an ordinary person reading that sentence would think that the problem with Citi is that some of its assets are somehow “distressed” or “toxic” in a way that’s causing a problem for the rest of the bank. Take the toxicity off its hands, and the rest can go merrily about its way. But that’s not right. We can argue ’till the cows come home as to what the assets in question are “really” worth, but at a minimum they’re worth $0. And in practice they’re sure to be worth more than $0. Assets with a positive value can’t be a problem for a company. A company gets into trouble because of its debts. Citi’s problem isn’t that it has toxic assets, it’s that it made loans backed with toxic assets. You don’t rescue banks by “tak[ing] distressed assets off the balance sheet of Citigroup or other troubled financial institutions.” The problem isn’t the assets, it’s the debts. You can deal with the problem by giving the banks vast sums of money in exchange for their toxic assets but in this case what’s solved the problem isn’t that the assets came off the balance sheet, it’s that the money you gave them got on the balance sheet. Alternatively, you can create a government-owned bad bank that owns the bad assets and assumes responsibility for much of the debt. In either case, though, the key element of the rescue is expenditure of taxpayer funds to service the debts, not anything that’s being done with the assets.

2 Comments:

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11:09 AM, March 11, 2009  
Anonymous bill in minneapolis said...

I did not follow the logic of this analysis.

Banks hold 'securities' - that is, packages of loans (mortgages back by real estate)that seemed safe because the banks paid a fee to insure them (usually to A.I.G.).

These securities are now of unknown value because no one is willing to buy them.

Because banks are required to carry these 'securities' on there books at what is estimated as the 'fair market value' of them, the bank must recognize huge losses on these securities (the difference between what they paid for them and what they are currently worth).

Thus, their capital basis is impaired (or they are may even have a negative net worth). As a result, they cannot make any new loans, must get new capital infusions and may even be required to call in loans they have made.

The result is the 'freezing up of capital markets.'

Since there are trillions of dollars of these securities out there, it is a big problem.

6:55 PM, March 11, 2009  

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