Toxicity

If anyone's been following the news of our imploding economy, they've probably been hearing the term "toxic assets" quite a bit. I don't know where it came from, but my guess is some marketing genius. It's serving the interests of bankrupt bankers quite well.

The story goes something like this: "Bank's balance sheets are weakened by the toxic assets on their books. The government must help them deal with their toxic asset problem." I am referring to US, not Canadian banks here.

This makes it sound as though otherwise healthy banks are being taken down by a toxic, poisonous assets. If we could somehow get rid of those, everything would be fine!

It would actually be really easy for a bank to get rid of "toxic assets". Declare them to be worthless, and remove them from their balance books. But they would still be insolvent.

A "toxic asset" is something the bank paid a lot of money for, but was backed by bad mortgage loans, and has become worth significantly less than what they paid for.

So suppose a hypothetical bank had 2 million in obligations (debts), and 2.1 million in "assets". But 500000 of those assets are "toxic", which means, in other words, worthless. Or worth a lot less than what they're valued at, let's say, 100000. So now the bank has a 300000 shortfall.

The problem isn't that "toxic assets" are weighing down its balance sheet. The problem is that it's balance sheet sucks, and they have more debt than assets.

So the bank is worthless. Most of the large American banks are currently in this situation. Worthlessness. The sensible thing would be to nationalize the banks, and force them to identify and write down their bad assets*. It would cost money to recapitalize the banks, but eventually they could be resold. This is how Sweden solved its financial crisis in the early 1990's, they even made a profit. The details get more complicated, but most sane economists agree on this overall strategy.

Instead, the Obama administration is talking about giving the banks money to help them "get the toxic assets off their balance sheets". The only way this could "work", ie. save the banks from bankruptcy, would be to pay the banks much more money than the assets are worth.

Its the same lousy plan that the Bush administration originally settled on, but changed after it was massively criticized by just about everyone. After careful consideration, Obama seems to be moving to reinstate it, on a larger scale. And his treasury secretary has been very clear in saying that he wants to avoid nationalization, that banks will be better managed in private hands.

Let's laugh at that for a second.

Giving money to the banks without taking ownership is just a large gift to the current shareholders and bondholders. Its reverse Robin Hood, taking money from the poor and middle class and giving it to the rich.

And this is just part of it. The stimulus plan being proposed, is massive, but also far too small, according to most economists. If it fails, we will probably see a new depression, weakness in the global economy of a decade or so.

Truly, we are doomed.


*Another problem in this crisis is that its not clear where all of the assets worth less than their value are. Much recent innovation in the financial industry consisted in making bad assets very, very complicated so that it looked like their were worth something.

If anyone's interested in reading more, this link gives a good summary:

http://www.nakedcapitalism.com/2009/02/bad-bank-assets-proposal-worse-than-you.html

And Martin Wolf of the Financial Times has been good recently, here is a good column:

http://www.ft.com/cms/s/0/4a44f222-f221-11dd-9678-0000779fd2ac.html?nclick_check=1

And Paul Krugman's blog and articles in the New York Times are essential reading.