The Trouble With Troubled Assets
JACKI LYDEN, host:
From NPR News, this is All Things Considered. I'm Jacki Lyden. President Obama's plan to recharge the economy chugs ahead on two tracks. The U.S. Senate holds a key procedural vote on the retooled stimulus package tomorrow, and just enough Republicans appear to be on board. The president's chief economic adviser, Lawrence Summers, is expecting some heat. Here he is on "FOX News Sunday."
(Soundbite of interview)
Dr. LAWRENCE SUMMERS (Director, National Economic Council): Yes, let's argue vigorously. Let's work through the differences.
LYDEN: The compromise is not sitting so well with Republicans who haven't climbed on board.
Senator JOHN MCCAIN (Republican, Arizona): This agreement is not bipartisan.
LYDEN: That's John McCain on CBS's "Face the Nation." On the other main track of this economic express is Treasury Secretary Timothy Geithner. He's overhauling the bank bailout, and the administration said today that it wouldn't unveil the new plan until Tuesday in deference to the Senate's stimulus vote. Geithner says the government will have to do much more.
Secretary TIMOTHY GEITHNER (Department of Treasury): Financial systems are built on trust and confidence. This economic crisis was caused, in part, by a loss of confidence in our financial institutions.
LYDEN: The big problem? Those so-called toxic assets. NPR's Scott Horsley reports on why they're so poisonous.
SCOTT HORSLEY: The problem of toxic assets has mushroomed on banks' balance sheets. Like mushrooms, these assets thrive in the dark, and it's not easy to tell which ones are really bad for you. But that's Mike Thompson's job.
Mr. MIKE THOMPSON (Managing Director, Standard and Poor's): It takes some work, but the reality is it's a myth that these things cannot be valued. The truth is out there.
HORSLEY: Thompson says he sometimes feels like Agent Mulder from the "X-Files," shining a flashlight into the dark corners of the financial world. In fact, he's a managing director at Standard and Poor's.
I asked Thompson to describe a toxic asset. He gives me an example - a big bundle of adjustable home loans, $2 billion worth, mostly from California, Florida and New York.
Mr. THOMPSON: It's a typical deal that was done, you know, in the vintage of 2006 which is kind of right before, you know, things started getting doubtful.
HORSLEY: When these mortgages were bundled into a security a few years ago, the payments from all those home loans were sliced and diced into some 40 different layers, or tranches. Each layer was to receive a particular pay-off. Those at the bottom were supposed to collect slightly more money, but with a caveat, they'd be the first to suffer if some of the mortgage holders stop making their monthly payments.
Mr. THOMPSON: It's probably going to find that the upper-tier tranche holders are going to be just fine. But it's all the folks that went and took the more risky pieces as you progressively went down the structural ladder that you see the pain.
HORSLEY: In fact, the banks and others holding the bottom layers have already lost nearly all that investment. And even some of the middle layers are considered toxic now because their value's in serious doubt. Payments to these middle layers will be sacrificed, if necessary, to protect investors at the top.
And for those on the bubble, the loss could be sudden. A relatively modest jump in the number of mortgage defaults say, from five percent to 10 percent, slashes the value of a mid-level security from 86 cents down to two cents.
Mr. THOMPSON: These are not a cascading gentle waterfall but more like falling off a cliff.
HORSLEY: The ominous thing is since Thompson first looked at this pool of mortgages last fall, half a dozen more layers have been pushed over that cliff by the worsening economy and rising defaults.
Mr. THOMPSON: You've had a kind of a wave of defaults. And it's overcoming these structures. It's a kind of like a massive flooding up the tranche structure, and it has taken investors completely by surprise.
HORSLEY: Big losses on these investments and the threat of more to come have made it hard for banks to make the new loans that are needed for the economy to recover. Duke Finance professor Campbell Harvey says the government needs to address the problem no matter how unpopular the remedies may be.
Dr. CAMPBELL HARVEY (International Business, Fuqua School of Business, Duke University): The alternative is like a mini-depression. And I don't think people want to go there.
HORSLEY: The government has considered a variety of fixes, from buying the bundled mortgages and other toxic assets itself to encouraging hedge funds to take them off banks' hands. One thing that's sure to be part of the government's plan is a foreclosure prevention effort to help borrowers stay in their homes and maybe keep the banks holding a slice of their mortgages from going over that cliff. Scott Horsley, NPR News, Washington.
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