It looks like the Obama administration may refocus the so-called Troubled Asset Relief Program on actually buying “troubled assets.” The idea of having the government buy troubled assets was what Congress thought it was approving when it passed the $700 billion bailout bill. But shortly after it received the authority to spend that money, Hank Paulson’s Treasury Department abandoned the idea in favour of making direct capital injections in troubled banks. Now, perhaps, the TARP may be used as originally intended.
So what are “troubled assets” anyway? A surprising number of people are very confused about what these assets are and why they are crippling the global financial system. Phrases like “toxic assets” only serve to confuse things more, leading people to suspect that the assets are somehow radioactive or cancer-causing. The alphabet soup of CDOs, MBS, CDS, ABS only makes the eyes of ordinary people glaze over. At the very least, people tend to think the assets are troubled because of some kind of complicated financial accounting voodoo that ordinary people can’t undersand.
The truth is far simpler. Troubled assets are just stuff that banks paid too much for. Mostly, that stuff is loans made to people who cannot afford to pay them off, secured by collateral that is worth less than the loan value. Those loans were made so people could buy everything from homes and cars to shopping malls and construction companies.
The reason they are financially crippling is that banks don’t want to admit how badly they overpaid, so they keep carrying worthless junk at inflated values on their balance sheets. The “systemic” problems arise because everyone knows the banks are holding junk that they are pretending are jewels. Investors and lenders don’t believe the assets are worth what the banks say they are, so they won’t lend or invest against the phoney valuations.
Let’s make this even more concrete. Imagine you bought a Batman comic book from the 1950s at the height of the comic book craze. Back in the 1980s and 1990s, a lot of people believed they could get rich buying and selling comic books from their grandparents’ attics. So maybe you would have believed that the May 1952 issue of Detective Comics, the one where Batman and Robin fight a “phantom menance” who perpetrates “famous crimes,” would be worth thousands of dollars. If you bought it for $2000 bucks, you might even have believed you were getting a great deal.
But now that the comic book bubble has burst, that comic will only fetch $200. You can gnash your teeth, complain that the storyline is really interesting, that the comic isn’t actually falling apart and should be worth much more. You might even think that one day people will be willing to pay thousands of dollars for comic books again. But if you were to try to borrow a couple of thousand dollars using the comic book as collateral, the lender would laugh at you. Your comic, you see, is a troubled asset.
When the government guarantees the value of a troubled asset, what it is really doing is promising to pay anyone who ends up owning it the difference between the phony, inflated value and the actual value it fetches on the market. Buying troubled assets, if that actually ever happens, works pretty much the same way: the government pays more than the asset is worth, exchanging something really valuable–dollars–for something that has a lot of, well, sentimental value for the bank.
There’s a joke about “famous crimes” here somewhere.
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