April 22, 2009
If it's toxic, is it really an asset?
Banks around the world are being dragged down by toxic assets, those mortgage backed securities investors gorged on during the housing bubble that have now pushed so many banks to the brink of insolvency.
Which raises the question, how much of an asset can something be if it's toxic?
While linguists might say it's a contradiction in terms, accountants say "toxic assets" actually defines them pretty well, said W. Bruce Johnson, professor of accounting in the University of Iowa's Tippie College of Business.
"These are securities that are real assets that generate cash flow for their owners," said Johnson. "They just don't generate as much cash flow as was priced into the security, so the value may be less than what the owner paid for it."
In general terms, toxic assets refer to the billions of collateralized debt obligations -- mostly mortgage-backed securities -- that many banks and investment institutions gobbled up in recent years. But when the real estate bubble popped, the economy tanked, and so many homeowners stopped paying their mortgages, those securities turned out to be not nearly as valuable as investors originally thought.
The uncertainties that arose from not having an accurate read on their actual value hammered the banks' bottom lines and stock prices. Eventually, many banks saw their total value of assets drop below the minimum capital requirements set by regulatory agencies, putting them in violation of federal law.
In some cases -- as with the case of Bear Stearns and Lehman Bros. -- those assets actually proved fatal.
Thus the term, "toxic assets."
Johnson said he doesn't know where the term came from because technically speaking, "toxic assets" don't exist, at least in accounting lingo.
"I don't know if that was coined by a journalist or a politician or someone who works in finance, but in accounting, we don't call anything a toxic asset," he said.
Instead, accountants refer to them by the far more general and far less dramatic term, "impaired assets." An impaired asset is anything of value that an owner can't sell for as much as they paid for it, Johnson said. For instance, moldy grain sitting in an elevator.
"Moldy grain can still be used, it still has value," Johnson said. "But it doesn't have as much value as the owner paid the farmer for it when it wasn't moldy."
So in a sense, mortgage backed securities are like moldy grain. They are worth something, just not what the bank paid for it.
"Any impaired asset has to be written down to some kind of realizable value as soon as it's declared impaired," Johnson said. "It's toxic in that it can lead to severe problems for the company that has to write it down to a value that's lower than what they expected."
And while a toxic asset might be killing one bank, it might eventually become a profitable asset for another.
"There are buyers for these kinds of assets and they could make money for someone," Johnson said.
VIDEO: Johnson describes Congress' reaction to toxic assets: http://tippie.uiowa.edu/news/media/ToxicAssets.m4v
STORY SOURCE: University of Iowa News Service, 300 Plaza Centre One, Iowa City, Iowa 52242-2500
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