Muddled language leads to muddled thought. We’re seeing that all too clearly in the discussions of the bailout. Increasingly, the use of the phrase “toxic assets” is, well, poisoning our ability to think clearly.
Just this afternoon, we witnessed a business news television anchor (we won’t name names here because we don’t want to embarrass Bill Griffeth) hectoring Congressional holdouts against the bailout. More than once he emphasised that banks weren’t lending to each other because of the toxic assets on their balance sheet.
Once you start thinking of the derivatives and mortgage backed securities held on the balance sheets of our financial institutions as “toxic” it is easy to conclude that they need to be removed in order to restore our financial health. The Hanke-Panke bailout plan looks far more sensible than alternative plans such as government insurance or recapitalization because it promises to take the toxicity out of the banks.
But the assets everyone is talking about aren’t actually toxic. If they were toxic, you wouldn’t have to buy them from banks. The banks would happily hand them over, and we’d bury them in the desert. Instead, the banks will be paid for the assets, at prices above what they would fetch in the open market. And that’s because the problem with the banks isn’t the toxicity of the assets—it’s that there is widespread doubt that the assets are worth the valuations assigned by the banks.
The reason why banks are charging such high rates for loans to each other is that they have doubts about the soundness of the balance sheets of other banks and know that others have doubts about their own soundness. In short, they fear that other banks only appear to be adequately capitalised due to an over-valuation of assets on their balance sheets.
Moreover, it’s simply not true that it is impossible to borrow with so-called toxic assets on your balance sheets. What’s impossible is to convince other financial institutions that are grappling with the same problem that your assets are worth almost as much as you thought they were when you acquired them. The more you keep trying to convince anyone of this, the more people will mistrust you. Welcome to the world of right now.
The phrase “toxic assets” was always just a metaphor. Now it’s a metaphor that is muddying up our thinking about this financial crisis. It’s time to dump “toxic assets.”