Not All Bad Assets Are Toxic Assets

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RENEE MONTAGNE, host:

Within the next week or so, the Obama administration is expected to release details of a plan to purchase toxic assets from the banks. Our Planet Money team has been trying to get a handle on the toxic assets that are out there. And guess what? It turns out some of them might not actually be all that toxic.

Here to explain that twist in the economic story is NPR's David Kestenbaum. Good morning.

DAVID KESTENBAUM: Good morning.

MONTAGNE: Okay. So, here we are. We all think we know what a toxic asset is and how bad it is, and yet, well, why don't you give us a definition?

KESTENBAUM: Well, actually, I brought one into the studio here.

(Soundbite of banging)

KESTENBAUM: Can you hear that?

MONTAGNE: I did hear a big flap.

KESTENBAUM: That's actually just the first 100 pages. I didn't want to destroy the printer by printing out the rest. The whole thing is 400 pages long. This is a mortgage-backed security, and it's a pool of about 5,000 mortgages - I read here - and that when it was issued there was just over a billion dollars supposed to be coming in from those mortgage payments.

So, you could actually buy a share in this thing and when people pay off their mortgages, you get paid. Though, as you can tell by the thickness of this thing, it's a little more complicated.

MONTAGNE: Okay. So, in theory, this bundle - is that right - of…

KESTENBAUM: Yeah, pool of mortgages.

MONTAGNE: Okay. Of mortgages - they're considered toxic because the mortgages on some of those pages are going bad.

KESTENBAUM: But also it's just the complexity of this thing. That's one reason people don't want to buy them right now. I mean, there are a details, like who is first in line to get paid when the money comes in - who's in the top tranche? That's how you say it. Sometimes there are fights between various investors about, you know, in different places in line, about how to handle the folks who are late on their mortgages.

So, some of the toxicity just comes from - because these things are so complex people don't want to buy them right now.

MONTAGNE: And David, you're saying, though, that some of these toxic assets, so called, aren't so bad.

KESTENBAUM: Yeah. You know, I've been hearing this from a lot of people who look into these things in detail. And there's an interesting study done by some people at Standard and Poor's, which took mortgage-backed securities like this. They looked at ones where the loans were made to high quality prime borrowers. And they found that even under really disastrous economic scenarios - so, if you owned one of these toxic assets, they say, you'd still get all your money back with interest.

However - here's the interesting part - if you had to go sell this thing, you might just get 50 cents on the dollar. So, here's Mike Thompson. He's a managing director at S and P, who worked on the study. And he said the market is just way more scared than it needs to be.

Mr. MIKE THOMPSON (Managing Director, Standard and Poor's): The market pricing is painting a portrait of the economy that's so dire that it's even worse than the Great Depression. And it's to the point where it's ridiculous.

MONTAGNE: David, why does the market have such a negative view?

KESTENBAUM: Well, one possibility is that the people out there really think that things are going to be worse than the Great Depression. But the other is that the market is just not interested in taking on much risk these days. Though Mike Thompson said he'd actually buy these things if he could.

Mr. THOMPSON: Personally, if I had, like, you know, a billion dollars of my own capital, I'd go on a buying spree and buy every prime senior tranche that I could get. But, you know, they're not as easy to come by as you think. The big money managers don't want to do something incredibly, gallactically stupid. They do not want to sell good assets.

KESTENBAUM: So, even if you wanted to buy these things, the people who have them are like no way I'm selling that for 50 cents; it's a worth a dollar, so…

MONTAGNE: Well, there must though be bad toxic assets out there. The big banks are taking billions of dollars of losses because of those toxic assets on their books.

KESTENBAUM: That's absolutely true, and that is the stuff, unfortunately, that the government is going to have to be buying in this plan that we're still waiting to hear the details of. The stuff we've been talking about today, we've sort of opened one of the least toxic canisters. Mike Thompson says he figures there's a couple trillion dollars of the good stuff, but the total toxic asset problem is much bigger.

Mr. THOMPSON: Globally, I've heard the number 12 trillion, and in the U.S., the estimates range anywhere from eight to ten trillion.

MONTAGNE: So, David, we started out with good news and we've managed to get back to the bad news.

KESTENBAUM: Sorry about that. Thompson does have a little good news, which is that - he says that the banks that have this bad stuff, they do seem to be working through it. You know, they're taking losses but the rest of their business is still profitable. And that if they can hang on for a couple of years, a lot of these toxic assets will sort of radioactively decay. You know, they'll go away. People will pay off their mortgages or they'll foreclose, and it'll just be resolved. If they can just hold on for a few years, the banks may be okay.

MONTAGNE: David, thanks very much.

KESTENBAUM: You're welcome.

MONTAGNE: NPR's David Kestenbaum is part of our Planet Money team. You can find more answers to your trillion dollar questions at our Planet Money Podcast and blog at NPR.org/Money.

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