Putting a price on toxicity...

One of the ideas put forth by the Obama administration is to create a bad bank that will help absorb bad assets (like toxic mortgage securities) from good banks, hold it over time and then sell the assets to recover some or most of what it had paid thus aiding the taxpayer. Freed from the drudgery of holding onto these toxic assets, the good banks would start lending again and bring our economy back to full steam.

Sounds easy - until one considers on how best to value the underlying toxic assets... as this example from the Times amply demonstrates...

The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of Standard & Poor’s, the credit rating agency. The financial institution that owns the bond calculates the value at 97 cents on the dollar, or a mere 3 percent loss. But S.& P. estimates it is worth 87 cents, based on the current loan-default rate, and could be worth 53 cents under a bleaker situation that contemplates a doubling of defaults. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors. The bond analyzed by S.& P. is just one of thousands that the government might buy or guarantee should it go forward with setting up a “bad bank” that would acquire $1 trillion or more of toxic assets from banks.

One hopes fervently that the Obama administration will do a fair job of valuing these assets in ways that will provide incentives for the taxpayer rather than give it all away to the banks who led us into this mess. Given the ill conceived mish-mash loaded into the current stimulus package winding its way through the Senate, one hopes that the financial bailout will contain less excreta.