When all you read is gloom, turn here for a much different perspective.

Sunday, March 22, 2009

How Toxic Assets Turn To Gold

All week you will probably hear about "toxic assets" and the government's plan to rid the banks of these "bad" assets on their balance sheets.

But several astute readers have already alerted us all:
Today's "toxic assets" are tomorrow's "hot buys." The next scandal is going to be stories on wealthy Wall Streeters making a fortune buying "toxic" assets financed by the government as the real estate market recovers.
That just might be the case. Here is one scenario that weaves a silver lining into all those assets the government just might be buying on our behalf...

Take the example of Mike. He bought a small condo in the burbs of DC for $200,000 several years ago. The market was hot; he could not go wrong his agent said. He put $20,000 down and took out a 7% note from Countrywide (now Bank of America) for $180,000.

Now conditions outside the beltway recently got bad for everyone. The housing market slumped. The condos in his complex are listed for $110,000 and not selling. To make matters worse, Mike lost his job in November and just missed the first loan payment ever in his life.

Is this mortgage a toxic asset for Bank of America? You bet.

Let's assume that under the new Treasury plan, a private investor fund and the government buy this asset at a discount. (And a whole bunch more just like them). Why? So Bank of America can show more cash and liquidity on it's books and restore confidence to it's depositors that it can cover any withdraw requests.

The story continues. Mike finds a job three months from now. He starts making his payments again. Further, because of the discount paid for the note, the investors and the government have lowered his monthly payments, principal, and will forgive his past back payments. He now is paying on a $120,000 note at 5%. His job looks quite stable.

Now let's look ahead 5 years. Mike has been current on his note ever since his new job. He has paid the investors and the government 5 years of interest at 5%. Condo values have recovered and several units in his building just sold for $230,000. Will anyone buy that note? You bet they will.

You will no doubt hear more details on the Treasury's plans. There may be more outrage at the government assisting big banks in their new quest to become liquid and trustworthy again. Remember that just because those assets might look toxic today on the US Government balance sheet, that doesn't mean they will be toxic forever. This just might be one of the better investments the Government has made on our behalf.


  1. With just $6 in at risk money from private sector and $78 dollars in equity and government guaranteed loans in the example of an asset purchase the Treasury gave to illustrate how the plan might work. I ask why bother with the private sector. The taxpayers of the US will be robbed by this plan. No wonder Wall Street hedge funds love this plan it continues the legalized robbery of the American people they get huge profits by just risking a small loss. The government should just bid max 40 cents on the dollar for the assets take it or leave it in a series of Dutch auction each with a fixed total dollar amount to spend. Like the way the Fed raises funds for the U.S. Government using a Dutch auction.

  2. Fabio,

    I love auctions... I am not sure that they would create the market movement that is being sought. The goal is to get the assets off the books and provide renewed liquidity in the top 19 banks.

    I doubt the Dutch auction would accomplish this.

    I also doubt that the taxpayers will be robbed. Banks stand to lose the most. And the taxpayer also stands to make the most with more skin in the game.


  3. GNE:

    Do you think this plan will get the banks to start up commercial construction projects that have been shelved or where funding has been halted during construction or will it really depend on whether consumer demand picks up substantially to revitalize these projects?

  4. Anonymous,

    Only the large comm construction project have been shelved. Most of the larger ones need to be financed by one of the top 19 banks.

    Smaller comm construction funding is still flowing nicely -- in fact at record levels...

    It would be my wager that if a construction co really does want to move forward that conditions will be favorable for that sometime before fall.


  5. Unfortunately, we're seeing banks (small, medium and large) shut down construction projects every day. With property values going down, banks don't see how they can justify putting more money in the projects with little expectation of getting paid back. I hope the Treasury plan will encourage new investors to jump in and get the projects rolling again.

  6. Anonymous,

    What region are you in? Some regions are now skyrocketing with respect to commercial construction... for instance Birmingham AL reported last friday that contracts are now up almost 90%


    Contraction has indeed happened since the big chill last October, but contraction is now slowing significantly.

  7. GNE:

    We're in Atlanta. I'm also aware of big projects shutting down in Las Vegas and Chicago
    where investors are taking the position that they would rather not get deeper in the venture given the uncertainties of the market for tenants. Let's hope values start climbing in the Fall and these projects get a second chance!

  8. It's great for Mike, great for the banks, great for the foolish.....not so great for the rest of us saps who have been prudent, responsible, paid our bills and saved for a rainy day.

  9. @iron308,

    Care to elaborate on why a plan to stabilize the big banks will not help those of us saps who have been prudent and responsible? And why appreciating assets are not so great for the rest of us?



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