The crisis led to a severe economic recession, with millions losing their jobs and many businesses going bankrupt. The U.S. government intervened with a series of measures to stabilize the financial system, including the Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment Act (ARRA). The Swedish authorities engaged McKinsey & Company to help design a solution, and chose to establish two bad banks, Retriva and Securum. Retriva took over all the nonperforming loans from Gota Bank sv and Securum took over the non-performing loans from Nordbanken, with the good bank operations continuing as Nordea. Lars Thunell was appointed to lead Securum, supported by Anders Nyrén and Jan Kvarnström to manage its toxic book, at the time valued at sek 51 billion.

Globalization, technology and the trade deficit

Economic downturns often lead to a surge in non-performing loans as borrowers struggle to meet obligations, as seen during the 2008 financial crisis when mortgage-backed securities became toxic due to widespread defaults. Regulatory changes, such as stricter capital requirements under Basel III, have also forced banks to reassess asset portfolios, potentially leading to toxic reclassifications. In a Peabody Award-winning program, NPR correspondents considered why there was a market for low-quality private label securitizations. They argued that a “Giant Pool of Money” (represented by $70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Further, this pool of money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income-generating investments had not grown as quickly.

Greece was different in that it concealed large public debts in addition to issues within its banking system. Several countries received bailout packages from the “troika” (European Commission, European Central Bank, International Monetary Fund), which also implemented a series of emergency measures. He stated that the “combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit cycles.”18Krugman described the run on the shadow banking system as the “core of what happened” to cause the crisis.

Instead of developing a company that is temporarily unable to pay, the bondholder is given an incentive to sue for bankruptcy immediately, which makes it eligible for sale to a bad bank. That was when it became clear that some of the biggest U.S. financial institutions were sitting on a vast quantity of worthless assets. In fact, they were losing value at a pace that many had not thought was possible. In the case of a credit default swap, the number and amount of payments in and out is subject to an undetermined risk. International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) provide frameworks for handling these assets.

Swedish banking crisis of 1992

Toxic assets are investments that are difficult or impossible to sell at any price because the demand for them has collapsed. There are no willing buyers for toxic assets because they are widely perceived as a guaranteed way to lose money. A toxic asset is a financial asset that has fallen in value significantly and for which there is no longer a functioning market.

On the previous day, 25 September 2008, the United States Office of Thrift Supervision (OTS) announced that it closed the holding company’s primary operating subsidiary, Washington Mutual Savings Bank, and had placed it into the receivership of the Federal Deposit Insurance Corporation (FDIC). Virtually all savings and checking account holders were not affected as the accounts were insured by the FDIC during the collapse, and subsequently transferred in whole to JPMorgan Chase. The holding company, Washington Mutual Inc was left without its major asset and equity investment, its former subsidiary Washington Mutual Savings Bank, and filed for bankruptcy the following day, the 26th. Dozens of U.S. banks received funds as part of the TARP or $700 billion bailout.388 The TARP funds gained some controversy after PNC Financial Services received TARP money, only to turn around hours later and purchase the struggling National City Corp., which itself had become a victim of the subprime crisis.

• Markets for some toxic assets froze in 2007, and the problem grew significantly worse in the second half of 2008.
• About $500 million of private-label RMBS trade in a typical day, according to the guys at Mission Peak Capital who helped Planet Money buy a toxic asset.
• In these circumstances, the bank may wish to segregate its good assets from its bad assets through the creation of a bad bank.
• The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), two large government-sponsored enterprises, are the two largest single mortgage backing entities in the United States.
• The principle assumes similar assets should have comparable valuations, but market stress often limits the availability of meaningful benchmarks.

Bad bank

• Lars Thunell was appointed to lead Securum, supported by Anders Nyrén and Jan Kvarnström to manage its toxic book, at the time valued at sek 51 billion.
• The former tells the story from the perspective of several investors who bet against the housing market, while the latter follows key government and banking officials focusing on the critical events of September 2008, when many large financial institutions faced or experienced collapse.
• ] 190 Bn € and 170 Bn € respectively from the failed WestLB and Hypo Real Estate.
• The term toxic asset was coined during the financial crisis of 2008 to describe the collapse of the market for mortgage-backed securities, collateralized debt obligations (CDOs) and credit default swaps (CDS).
• No loss of a job, no medical emergency, they were underwater before they even started.

In short, this allows the Treasury to purchase illiquid, difficult-to-value assets from banks and other financial institutions. The targeted assets can be collateralized debt obligations, which were sold in a booming market until 2007, when they were hit by widespread foreclosures on the underlying loans. TARP was intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses. The unregulated creation and trade of derivatives, combined with excessive leverage and misplaced confidence in the housing market, were equally significant contributors.

Concerns regarding the stability of key financial institutions drove central banks to take action to provide funds to encourage lending and to restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions, assuming significant additional financial commitments. In 2012 the Spanish government granted powers to the Fund for orderly restructuring of the bank sector (FROB) to force banks to pass toxic assets to a financial institution whose role is to remove risky assets from banks balance sheets toxic asset wikipedia and to sell off the assets at a profit over a 15-year period.

With potential sellers and buyers unable to agree on prices, the markets froze with no transactions occurring. Valuing toxic assets is challenging, requiring a balance between accounting principles and market realities. The discounted cash flow (DCF) method estimates the present value of anticipated future cash flows, making it particularly useful for long-term assets like troubled loans. Employing a discount rate that reflects the asset’s risk premium is crucial, with higher-risk assets requiring higher discount rates to account for cash flow uncertainty.

Toxic Assets

Several hundred civil lawsuits were filed in federal courts beginning in 2007 related to the subprime crisis. Justice Department topped a deal the regulator made the previous year with JPMorgan Chase over similar issues.430 Morgan Stanley paid $2.6 billion (~$3.27 billion in 2023) to settle claims in February 2015, without reaching closure on homeowner relief and state claim. As of April 2012, the government had recovered $300 billion of the $414 billion that was ultimately distributed to them via TARP. Some elements of TARP such as foreclosure prevention aid will not be paid back. Estimated taxpayer losses were $60 billion.380 For a summary of U.S. government financial commitments and investments related to the crisis, see CNN – Bailout Scorecard.

Timeline of changes to the TARP

The value of the assets were very sensitive to economic conditions, and increased uncertainty in these conditions made it difficult to estimate the value of the assets. Banks and other, major financial-institutions were unwilling to sell the assets at significantly reduced prices, since lower prices would force them to significantly reduce their stated assets, making them appear insolvent. Troubled loans, or non-performing loans (NPLs), are loans where borrowers have defaulted or are likely to default.

These loans challenge financial institutions by impacting liquidity and capital adequacy ratios. Under IFRS 9, banks classify loans into stages based on credit risk, with Stage 3 loans requiring lifetime expected credit loss (ECL) provisions. This involves modeling potential losses over the loan’s remaining life, considering factors like borrower creditworthiness and macroeconomic conditions.

Savings surplus or investment deficit

Market comparables are another valuation technique, commonly applied to distressed securities. This method benchmarks an asset against similar market instruments to determine its value. However, during volatile markets, finding comparable trades can be difficult, complicating the process. The principle assumes similar assets should have comparable valuations, but market stress often limits the availability of meaningful benchmarks.