Toxic Assets

AAA

DEFINITION of 'Toxic Assets'

An asset that becomes illiquid when its secondary market disappears. Toxic assets cannot be sold, as they are often guaranteed to lose money. The term "toxic asset" was coined in the financial crisis of 2008/09, in regards to mortgage-backed securities, collateralized debt obligations and credit default swaps, all of which could not be sold after they exposed their holders to massive losses.

INVESTOPEDIA EXPLAINS 'Toxic Assets'

A toxic asset can be best described through an example:

If John Doe buys a house and takes out a $400,000 mortgage loan with a 5% interest rate through Bank A, the bank now holds an asset - a mortgage-backed security. Bank A is now entitled to sell the asset to another party (Bank B). Bank B, now the owner of an income-producing asset, is entitled to the 5% mortgage interest paid by John. As long as house prices go up and John continues to pay his mortgage, the asset is a good one.

If, however, John defaults on his mortgage, the owner of the mortgage (whether Bank A or Bank B) will no longer receive the payments to which it is entitled. Normally, the house would then be sold, but if the house price has declined in value, only a portion of the money can be regained. As a result, the securities based on this mortgage become unsellable, as no other party would pay for an asset that is guaranteed to lose money.

In this example, the mortgage-backed security becomes a toxic asset.

RELATED TERMS
  1. Collateralized Debt Obligation ...

    An investment-grade security backed by a pool of bonds, loans ...
  2. Off Balance Sheet - OBS

    An asset or debt that does not appear on a company's balance ...
  3. Toxic Debt

    Debt that has a lower chance of being repaid with interest. Toxic ...
  4. Zombie Bank

    A bank or financial institution with negative net worth. Although ...
  5. Credit Default Swap - CDS

    A swap designed to transfer the credit exposure of fixed income ...
  6. Troubled Asset Relief Program - ...

    A government program created for the establishment and management ...
RELATED FAQS
  1. What are the most common leveraged ETFs that track the drugs sector?

    The most common leveraged exchange-traded funds (ETFs) that track the pharmaceutical industry are the two offered by Proshares: ... Read Full Answer >>
  2. What is required to become an accredited investor in a private placement?

    The term "accredited investors" is defined by the U.S. Securities and Exchange Commission (SEC) as individuals with a net ... Read Full Answer >>
  3. How does inflation affect a company's short-term investments?

    Inflation marginally erodes a company's short-term investments. Short-term investments are typically ultra-safe liquid assets, ... Read Full Answer >>
  4. How can an investor profit from a decline in the aerospace sector?

    Several forms of speculation enable investors to profit from a decline in the aerospace sector. Short selling aerospace stock ... Read Full Answer >>
  5. Why should you invest in tangible assets?

    Savers who deliberately buy tangible assets for investment purposes value their tangible goods as a form of value diversification ... Read Full Answer >>
  6. How much of the asset management industry has moved from traditional managers to ...

    While the exact numbers are difficult to calculate due to variations in measurement and the overall growth of the asset management ... Read Full Answer >>
Related Articles
  1. Insurance

    Should You Buy Banks' "Toxic" Assets?

    The Public-Private Investment Progam is part of the government's effort to fix the failing financial sector. But is it a good investment?
  2. Insurance

    Dissecting The Bear Stearns Hedge Fund Collapse

    Learn how a deadly mix of greed and leverage cost investors millions.
  3. Insurance

    Liquidity And Toxicity: Will TARP Fix The Financial System?

    TARP is the government's attempt to forestall a deep, extended recession. Will it work?
  4. Bonds & Fixed Income

    Are High-Yield Bonds Too Risky?

    Despite their reputation, the debt securities known as "junk bonds" may actually reduce risk in your portfolio.
  5. Bonds & Fixed Income

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  6. Mutual Funds & ETFs

    The 2007-08 Financial Crisis In Review

    If you don't know how the recession began, read on to learn more.
  7. Trading Strategies

    Are These the Top Monthly Dividend Stocks?

    Interested in monthly dividends? Here are two stocks to watch.
  8. Forex Strategies

    An Introduction To Trading Forex Futures

    We explain what forex futures are, where they are traded, and the tools you need to successfully trade these derivatives.
  9. Investing

    Bitcoin Vs. Litecoin: What's The Difference?

    Litecoin is often referred to as "the silver to Bitcoin's gold." But what is Litecoin, and how does it compare to its more famous counterpart?
  10. Forex Education

    Why Governments Are Afraid Of Bitcoin

    Bitcoin is the first decentralized peer-to-peer payment network and cryptocurrency. Governments may fear Bitcoin because its value is determined by users and not central governments or banks. ...

You May Also Like

Hot Definitions
  1. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles to get life insurance. 2. A situation where sellers have ...
  2. Wash Trading

    The process of buying shares of a company through one broker while selling shares through a different broker. Wash trading ...
  3. Fixed-Income Arbitrage

    An investment strategy that attempts to profit from arbitrage opportunities in interest rate securities. When using a fixed-income ...
  4. Venture-Capital-Backed IPO

    The selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative ...
  5. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless ...
  6. Market Failure

    An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers ...
Trading Center