The term was in limited use at least as early as 2006, and may have been coined by or popularized by Angelo Mozilo, founder of Countrywide Financial, who used the term "toxic" to describe certain mortgage products in emails in spring of 2006, as revealed in SEC filings:[2] Regarding Countrywide's subprime 80/20 loans: When the supply and demand of a good equal each other, so buyers and sellers are matched, one says that the "market clears".
Therefore, it reaches equilibrium at a price that both buyers and sellers will accept, and, in the absence of outside interference (in a free market), this will happen.
The value of these assets was very sensitive to economic factors, such as housing prices, default rates, and financial-market liquidity.
Furthermore, banks and other large financial institutions were reluctant to accept lower prices for these assets, since lower prices would force them to recalculate the total value of their assets, and, if the loss was sufficiently large, force them to declare a negative total value.
[4] Alternatively, potentially insolvent banks with toxic assets will seek out very risky speculative loans to shift risk onto their depositors and other creditors.
On March 23, 2009, U.S. Treasury Secretary Timothy Geithner announced a Public-Private Investment Partnership (PPIP) to buy toxic assets from banks.
[7] Economist and Nobel Prize winner Paul Krugman has been very critical of this program, arguing that the non-recourse loans lead to a hidden subsidy that will be split by asset managers, bank shareholders, and creditors.
[10] However, that argument ignores the possibility of simultaneously adjusting bank liabilities by legislation or regulation, as requested in the September, 2009, $24 billion plan proposed by FDIC chair Sheila Bair,[11] which would have shielded shareholders but could have led to non-astronomical management bonuses.
Because the number of commercial bankruptcy filings continues to increase, there is evidence for negative feedback pressure indicating that toxic assets still need to be addressed.
[13] The term "toxic asset" is generally associated with financial instruments like CDOs ("collateralized debt obligations", assets generated from the resale of portions of a bank's mortgages), CDS ("credit default swaps"), and the subprime mortgage market—particularly the lower tranches—but the term does not have a precise definition.
Toxic security is the name applied during the aftermath of the subprime meltdown to financial instruments which cannot be readily identified as an asset or a liability.
This is an insurance-like trading strategy: one institution writes swaps or options that provide it with regular payments in exchange for taking another’s risk of default.