What are Toxic Assets?
Toxic assets are assets that have experienced a significant drop in value and lack an active market where they can be sold. Toxic assets are also known as troubled assets.
How Do Toxic Assets Work?
The most famous examples of toxic assets are subprime mortgages. After the real estate market collapsed in 2007-2008, subprime mortgages lost much of their value and became almost impossible to sell. Because the market for subprime mortgages was illiquid, any owner of a subprime mortgages had to sell them at a fire-sale price if it was necessary to unload them. Banks, insurance companies and hedge funds had a relatively high number of these toxic assets on their balance sheets, and once their value plummeted, many of these firms found that they were insolvent.
Why Do Toxic Assets Matter?
The U.S. Department of the Treasury created TARP (Troubled Asset Relief Program) in 2009 to purchase or insure up to $700 billion of toxic real estate assets owned by banks and other private financial institutions. TARP mainly targeted a real estate derivative called a 'collateralized debt obligation,' or CDO, which had enjoyed active trading until widespread foreclosures caused the secondary market for CDOs to dry up. By purchasing their toxic assets, TARP allowed banks to stabilize their balance sheets, avoid further losses and begin lending again.
