Fisher Investments Editorial Staff
US Economy, Investor Sentiment

Who Loves Toxic Waste?

By, 03/22/2011

Story Highlights:

  • The US Treasury will sell $142 billion in mortgage securities over the next year for an estimated $15-20 billion profit.
  • TARP and the Public-Private Investment Program were similarly profitable.
  • for the recovery in “toxic asset” values shows how silly mark-to-market was.
  • The unwinding of these programs confirms credit markets continue to improve and stabilize.

In 1985’s cult classic Real Genius, Val Kilmer’s character sported a t-shirt reading “I [heart] Toxic Waste,” which is suddenly appropriate again given Monday’s announcement the US Treasury plans to sell $142 billion of mortgage-backed securities (MBS)—the so-called “toxic assets” bought in late 2008 during the height of the financial crisis. 

The fact the Treasury currently has $142 billion worth of these assets that haven’t died shows MBS weren’t inherently as “toxic” as deemed—they merely appeared so thanks to write-downs forced by a misguided accounting rule, FAS 157 or “mark-to-market,” which has since been amended. When combined with the government’s estimated $15-20 billion profit, the moniker “toxic assets” seems even more dubious.

The MBS involved in Monday’s announcement are 30-year and 15-year (to a lesser extent) fixed rate mortgages backed by Fannie or Freddie. Fannie and Freddie’s implicit government guarantee was thrown in doubt when those entities came under fire, hence the government’s stepping in. That they’re now being sold (likely in monthly installments of around $10 billion) at a gain is a sign the agency MBS market has improved substantially since late 2008.

The Treasury’s plan is just another sign of resurgent demand for formerly “toxic” debt—much of which was written off not long ago. That the government has buyers willing to pay a premium shows just how silly mark-to-market accounting rules were. We’ve long said banks shouldn’t have been forced to put MBS’ market values on their balance sheets, since the underlying assets were mostly fine and many banks never intended to sell at depressed prices. Today’s prospective MBS profits confirm these vehicles were in far better shape than their depressed market prices indicated and shouldn’t have done banks much harm if not for mark-to-market, possibly negating the need for government intervention and perhaps even stopping the financial panic before it began.

This move by the Treasury is the latest example of the US government profiting from its bailout efforts to stabilize the mortgage market and banking sector during the financial crisis. The Public-Private Investment Program, which involved the Treasury and a few private investment firms joining forces to get the most distressed assets off banks’ balance sheets, returned 27% through January 2011. Of the TARP funds lent to banks, 99% have been repaid, and the Treasury estimates they’ll reap about $20 billion when all’s said and done. AIG, long thought to be the biggest TARP albatross, now wants to buy back the subprime assets it sold to the Fed in late 2008, and its offer represents a $1.5 billion profit to the government (though this is far from the government’s entire AIG investment). If that weren’t enough, the Fed’s hesitating on the AIG offer, as they think even higher profits will come with waiting. This debt is hardly toxic, and indeed the MBS market, which was at the very heart of the financial panic—has shown much improvement and stabilization.  

Not that we’re high-fiving the government or calling TARP a “super fund” (though we’re sorely tempted). Don’t forget, the government’s wonky intervention caused substantial turmoil as the crisis unfolded. But that they’re steadily unwinding this intervention, making profits on those taxpayer investments, and the US economy is still growing, is a good sign. After all, many folks feared the US’s economic rebound was solely due to the government’s propping up real estate and financials, and we’d see the dreaded double dip once this stopped. Perhaps now, with firms standing on their own and the government seeing a return on its investments, folks will better see the real reasons for the economy’s resilience—things like higher productivity and business investment

There will always be market volatility—but at the least it shouldn’t be tied to uncertainties over government bailouts.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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