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. Federal Reserve Board - FRB

    The governing body of the Federal Reserve System. The seven members ...
RELATED FAQS
  1. How are American Depository Receipts (ADRs) exchanged?

    American depositary receipts (ADRs) are bought and sold on regular U.S. stock exchanges, either in the over-the-counter market ... Read Full Answer >>
  2. Who or what is backing municipal bonds?

    Municipal bonds are backed by dedicated taxes or revenue sources related to specific projects, or by the full faith and credit ... Read Full Answer >>
  3. What are the differences between debt and equity markets?

    The basic differences between the debt and equity markets include the type of financial interest they represent, the way ... Read Full Answer >>
  4. What does it signify if the term structure of an interest rate's curve is positive?

    When the term structure of interest rates is positive, it is a signal to economists the short-term yields on similar bonds ... Read Full Answer >>
  5. What do cities do with the funds generated from municipal bonds?

    Funds generated from the sale of municipal bonds may go to provide for unspecified, general government financial needs, or ... Read Full Answer >>
  6. How is the standard error used in trading?

    The standard error is used in trading as an indicator to measure the volatility in price in relation to a linear regression ... 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. Stock Analysis

    Southwest & Cheap Oil: The Perfect Combination?

    Discover how falling oil prices (and well-timed futures contracts) benefit Southwest Airlines.
  8. Bonds & Fixed Income

    What are Floating-Rate Notes?

    A floating-rate note is a debt instrument with an interest rate that “floats,” or varies. They are also called floaters.
  9. Economics

    As Fed Prepares To Move, Gold Is Losing Its Luster

    Last week’s Semi-Annual Monetary Policy Report to Congress returned investors’ focus back to the fundamentals, and a general upbeat of the economy.
  10. Mutual Funds & ETFs

    Top 3 ETFs For Investing in Brazil

    Discover information and analysis of some of the most popular and best performing exchange-traded funds that offer investors exposure to Brazil.

You May Also Like

Hot Definitions
  1. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  2. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  3. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
  4. Sin Tax

    A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. ...
  5. Grandfathered Activities

    Nonbank activities, some of which would normally not be permissible for bank holding companies and foreign banks in the United ...
  6. Touchline

    The highest price that a buyer of a particular security is willing to pay and the lowest price at which a seller is willing ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!