The plan announced this week by the US Treasury secretary Tim Geithner is designed to clear away a large load of so-called “toxic assets” clogging up America’s financial system. But what are these assets? And how will the plan work?
Normal loans go bad every time the economy enters a recession, as companies’ profits fall and mortgage-holders lose their jobs. But on top of that familiar problem, banks and other financial institutions have created complex financial securities, called derivatives, so blindingly complicated that even the people creating them didn’t really understand them.
With the financial markets in a state of high anxiety and uncertainty, no-one can be sure what these assets are really worth. They haven’t just gone sour. They have become toxic.
The banks and financial institutions that own these assets are caught in a bind. No-one wants to buy the assets from them at anything but extremely low prices. Selling them at those knock-down values could mean realizing huge losses and admitting they are insolvent – meaning they cannot meet their own liabilities. But until they can clear them off their books, the banks don’t want to take any more risks by lending out more money. Play the explainer below to see Mr Geithner’s strategy for unblocking the financial system.
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