DEFINITION of 'Troubled Asset'

A troubled asset is an asset on the balance sheets of financial institutions that has experienced a significant drop in value, such as a mortgage, asset-backed security and loan made to borrowers who cannot afford to pay it back. Troubled assets can turn into toxic assets if there is no liquid market where they can be sold.

BREAKING DOWN 'Troubled Asset'

The most famous examples of troubled assets are subprime mortgages and collateralized debt obligations (CDO), which lost much of their value and became almost impossible to sell, after the housing boom collapsed in 2007-2008. Because secondary markets froze during the financial crisis, banks could only sell them at fire-sale prices to get them off their balance sheets. As a result, troubled and toxic assets threatened to make many U.S. financial institutions insolvent and turn them into zombie banks.

In response, the government introduced the Troubled Asset Relief Program in October 2008, which gave the U.S. Treasury the power to buy troubled assets from financial institutions, in order to provide them with liquidity and stabilize the financial system. It defined these troubled assets as mortgages, mortgage backed securities and instruments derived from these, as well as any other financial instrument the purchase of which is necessary to promote financial market stability.

The Federal Reserve also introduced rigorous bank stress tests, to force the weakest banks to raise private capital and sell off toxic legacy assets, in order to strengthen their balance sheets sufficiently to be able to withstand future shocks and resume lending.

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