Turning Toxic Assets into Gold

All week you will probably hear about "toxic assets" and the government's plan to rid the banks of these "bad" assets on their balance sheets.

But several astute readers have already alerted us all:

Today's "toxic assets" are tomorrow's "hot buys." The next scandal is going to be stories on wealthy Wall Streeters making a fortune buying "toxic" assets financed by the government as the real estate market recovers.

That just might be the case. Here is one scenario that weaves a silver lining into all those assets the government just might be buying on our behalf...

Take the example of Mike. He bought a small condo in the burbs of DC for $200,000 several years ago. The market was hot; he could not go wrong his agent said. He put $20,000 down and took out a 7% note from Countrywide (now Chase (JPM)) for $180,000.

Now conditions outside the beltway recently got bad for everyone. The housing market slumped. The condos in his complex are listed for $110,000 and not selling. To make matters worse, Mike lost his job in November and just missed the first loan payment ever in his life.

Is this mortgage a toxic asset for Chase? You bet.

Let's assume that under the new Treasury plan, a private investor fund and the government buy this asset at a discount. (And a whole bunch more just like them). Why? So Chase can show more cash and liquidity on it's books and restore confidence to it's depositors that it can cover any withdraw requests.

The story continues. Mike finds a job three months from now. He starts making his payments again. Further, because of the discount paid for the note, the investors and the government have lowered his monthly payments, principal, and will forgive his past back payments. He now is paying on a $120,000 note at 5%. His job looks quite stable.

Now let's look ahead 5 years from now. Mike has been current on his note ever since his new job. He has paid the investors and the government 5 years of interest at 5%. Condo values have recovered and several units in his building just sold for $230,000. Will anyone buy that note? You bet they will.

You will no doubt hear more details on the Treasury's plans. There may be more outrage at the government assisting big banks in their new quest to become liquid and trustworthy again. Remember that just because those assets might look toxic today on the US government balance sheet, that doesn't mean they will be toxic forever. This just might be one of the better investments the government has made on our behalf.

Comments

[huskerbob:]

Whoops! You forgot to mention that Mike also owns a condo in Miami, 4 in Phoenix, and 12 in Las Vegas (stated income loans don't you know).
He stopped paying on 5 of them 4 years ago, but these mortgages can be resurrected for sale, along with any other non performing junk the banks can dig up.
It seems highly unlikely that the US government is the only entity to correctly see the value of these products. The whole point of this exercise is to overpay for the assets. Private investors will buy on their own for the right price, but why should the banks take a big loss? The only loser should be the middle class, so that's what we're gonna do.
I guess the value is such a slam dunk, we are going to make no recourse loans with the taxpayer's money!
These assets aren't toxic, just overpriced.
Why not just do the same thing for homeowners? Let the government use your tax dollars to help investors buy your neighbor's house at 2006 prices. It's just as stupid, and it will buy a lot of votes.

Mar 23 06:10 AM

[Dave Wrixon:]

Actually if Bernanke manages to stoke up inflation to 20% or more you could well be right.

Mar 23 06:19 AM

[apppro:]

It's amazing how all those 'Legacy' (I won't use the T word) assets that were said to be worthless are now just worth_less!! Real crapolla.
The very short hedge funds that lobbied FASB to have M2M instituted, and
The very short hedge funds that lobbied the SEC to get rid of the uptick rule, and
The very short hedge funds that used those 2 parameters to create scenarios to convince everyone that the CDO's of the monolines and then the investment banks were ALL worth $0.00, so
Those same short hedge funds could cover their short positions, and
NOW they get to buy all those assets are bargain prices and using our money too boot!!!

Mar 23 06:55 AM

[a fat panda:]

Great. So the solution to our credit crunch is to tie-up capital in broken real estate deals for five years. Since no one wants the real estate now we are going to take money from tax payers to pay people to tie up this capital. That is genius.

Mar 23 07:19 AM

[Gravity404:]

Countrywide is Bank of America not Chase.

Mar 23 10:22 AM

[Gravity404:]

And....and...Mike is now apprearing on 60 Minutes telling eveyone how the rotten banks made him sign his name at the bottom of the loan application stating (err...swearing) that everything is true - His $90K per year salary; not his $45K. And, he didn't understand the ARM and interest only, as he thought he could buy that $1 million house and pay $1,000 per month. And live happily ever after.

No one takes responsibility; except for the ones that were responsible the whole time.

60 Minutes gets their rating by reporting SOME of the facts while appealing to the emotional side of the same IRRESPONSIBLE.

Mar 23 10:34 AM

[Ishortyou:]

Next step is to fix the ovewhelming oversupply in the housing market feeding from foreclosures, new house starts (500k/month), resales. This needs to be fixed by whatever means necessary even if it takes to burn the oversupply down! and shot down the homebuilders!

Mar 23 11:27 AM

[The Good Ne...:]

@Gravity,

Thanks for the catch on BAC.

GNE

Mar 23 11:42 AM

[Glen L.:]

The rosy scenario is ridiculous. After Mike finally takes a job as a field hand he'll be making a third of what he did as a bank teller. And his condo will only be worth $75,000 in inflation-adjusted dollars, and never was worth more than that in the first place. Mike is a sucker, and so are all the people who voted for the crooks and madmen who put us in this hole in the first place, and are digging a hole of unfathomable depth for the succeeding generations.

Mar 23 12:12 PM

[kenley kyle:]

This scenerio does not acknowledge how the developer that filed bankrutpcy last month foreclosed on 18 condos in Mike's building and that comp sales are actually 60k not 122k. It could take longer than 5 years for Mike to get that 230k you sited.

Mar 23 07:34 PM