Toxic Assets is a coined phrase for those financial assets which saw their actual value plummet. Toxic assets do not have well working markets anymore, making them difficult or impossible to sell for a price on which the owner will agree. The term arose as a popularly coined phrase during the financial crisis of 2007-2010. Toxic assets proved to have a major part in causing the financial crisis.
As toxic assets’ markets seize up, they are called frozen markets. Many markets for these toxic assets froze up starting in 2007. The problem only continued to grow exponentially worse in the second half of the following year 2008. A number of elements combined to lock up the markets for toxic assets. These assets had values that proved to be extremely vulnerable to the worsening economic situation. As uncertainty only grew in this scenario, finding a value for toxic assets became more difficult. In the resulting frozen markets, banks and similar lending institutions chose not to unload these assets for greatly diminished prices. The reason for it lay in their fear that such drastically lower prices would force them to mark down all of their holdings, so that they became insolvent or bankrupt.
Typically, toxic assets are able to clear when the supply and demand of them reach the point that buyers and sellers will come together. This did not occur in the financial crisis starting in 2007. As a number of the financial assets simply hung around on banks’ balance sheets, experts declared that the markets had broken down.
Another way of putting this is that because banks would not write down the prices on the assets, the price of them proved to be overly high. Buyers knew that these assets were now worth far less than the selling banks hoped to realize for them. This kept the sellers’ price expectations far higher than buyers were willing to pay.
Toxic assets mostly arose as a result of banks and other investment banks deciding to pour enormous sums of money into new and complex financial assets like credit default swaps and collateralized debt obligations. These highly leveraged assets had values that turned out to be extremely vulnerable to a variety of economic conditions like the rates of default, prices of houses, and liquidity of financial markets. These toxic assets threatened to destroy the entire financial system and did manage to take down a number of venerable institutions like Bear Stearns, Lehman Brothers, and Washington Mutual Bank, the country’s largest savings and loan institution. As a result of the carnage created by these highly leveraged, speculative investments in toxic assets, experts have named them financial weapons of mass destruction.