How to value toxic assets

There should really be a question mark at the end of that title.  As far as I can tell, no-one really knows.

I mentioned yesterday that the US government has just given a guarantee to Bank of America against losses in a collection of CDOs and other derrivatives that BofA and the US government agreed were currently worth US$81 billion (the headline guarantee is for $118 billion, but $37 billion of that is cash assets that are unlikely to lose value).

Last November the US government did the same thing for Citigroup, but the numbers there were much larger:  US$306 billion.

The deal with Bank of America is a better one because the $81 billion of toxic assets had to be bundled with $37 billion of cash that will almost certainly create a (small) profit to partially offset any losses.

Nevertheless there is a general question of how they arrived at those numbers given that the market for those assets has dried up:  nobody is buying or selling them, so there aren’t any market prices to use.

The problem is hardly unique to America.  From today’s FT:

[M]inisters and regulators are examining loans already on banks’ balance sheets, which are becoming more impaired as the economy deteriorates. Concern about the eventual size of losses on them is one reason British banks have recently reined in lending.

Final decisions are not expected imminently from the Treasury. But Mr Brown has spoken recently of the problem of “toxic assets” on balance sheets, raising speculation that a “bad bank” solution will be adopted.

The prime minister has also said Britain is looking at different models. These include schemes whereby the government buys up bad assets in return for cash or government bonds; and schemes where banks keep the assets on their balance sheets but the government insures them against loss. The latter method was adopted by the US government this week to shore up Bank of America.

The Bank of England is moving towards the idea of a so-called bad bank, since private sales of bank assets are proving difficult or impossible. But it raises difficult questions: how should assets be valued; should gilts be issued for the purchases; or should money be created.

Mr Darling also notes that a US toxic asset relief scheme proved difficult to launch because of banks’ refusal to sell assets at a price ­acceptable to the government. Offering insurance against future losses on bad assets could prove more attractive.

“The other problem is that the banks haven’t asked us to do this yet,” said one government official. “We would be asking the banks to give us a load of crap and they’d say to us: ‘What are you going to pay us then?’”

The credit crisis will not end until we know which banks are solvent and which are not, and we won’t know that until we know the value of those CDOs.  Despite the fact that they can’t sell them, banks are loath to write them off completely.  Also from the FT today:

With speculation growing that the government will be forced to stage another bank rescue, the prime minister told the Financial Times he had been urging the banks for almost a year to write down their bad assets. “One of the necessary elements for the next stage is for people to have a clear understanding that bad assets have been written off,” he said.

Speaking amid mounting market concerns that banks face further heavy losses, Mr Brown said: “We have got to be clear that where we have got clearly bad assets, I expect them to be dealt with.”

Is it just me, or do you get impression that we’re watching a very expensive game of chicken here?

5 Responses to “How to value toxic assets”


  • ..in my view, confidence in the financial system has collapsed to the point where each announcement of more billions pumped in by governments has been followed by new black holes that suck in whatever is being thrown at it with barely a ripple. From my feeble attempts at understanding:
    the causes lie in a blowout over many years of derivatives leveraged by astronomical figures to unsustainable levels. The subprime mortgage collapse might have been the trigger but it would have happened anyway. Because of the bailouts now going on, we are putting fingers in dykes but the holes are winning. What the system needs is a cleanup, not a bandaid. In an understandable reaction, banks have (i) written off more questionable loans/mortgages etc. that are not all a total loss, (ii) clamped down on credit, and are still uncovering toxic assets where they had forgotten to look or didn’t know they existed???? It appears now that it is not just the repackaged subprime, CDOs etc. – so how long do we have to wait to get a clear picture how deep the hole really is? We would like to know where these ever greater losses from i.a. Citibank, BoA etc are coming from, we are getting the figures but not much else, except the demand for more money from governments which having said A cannot now not say B….
    Finally, I think that the term ‘Toxic Assets’ should be reserved to paper that has at least some underlying asset like a property, it is being packaged together with a lot of now worthless derivatives.

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