Banks load up on toxic assets
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Tess Vigeland: We’ve been talking a lot on this program about those so-called “troubled assets” weighing on bank balance sheets. Distressed loans, mortgage-backed securities, all those arcane financial products we’ve come to know and not love. Well this week the Treasury Department is expected to announce details of its plan to get banks to unload some of those assets. So we were surprised to hear from the Federal Reserve that, rather than unloading, some are actually loading up on the very things that got them in trouble. Our New York bureau chief Amy Scott has the details.
AMY SCOTT: Mortgage-backed bonds have been blamed for kicking off the financial crisis. So you may be surprised to hear that big banks have increased their holdings of certain securities by more than 5% since April. Why would they be buying this stuff just as the government is trying to get them to sell assets? Leo Tilman has one idea.
LEO TILMAN: These securities are extremely cheap.
Tilman runs an advisory firm that specializes in risk management. Most of these bonds are still paying interest. And Tilman says some are trading at a 25% discount.
He says banks figure they can buy them cheap now, and sell them at a profit when the economy recovers.
TILMAN: Unless we go into a double-dip recession or some kind of highly adverse environment, they can probably capture significant price appreciation.
Banks may also be betting on a bump from the Treasury’s public-private partnership.
The plan is meant to entice private investors to buy troubled securities. Linus Wilson teaches finance at the University of Louisiana at Lafayette.
He says if the partnership creates more demand for the bonds, the banks could make a quick profit.
LINUS WILSON: It might lead to higher prices, maybe temporarily higher prices, and they could make money from that.
Wilson says the banks are taking a risk. They’re likely buying the highest quality bonds. But mortgage defaults are expected to keep rising. Still, he says, by buying those risky securities banks are helping revive the mortgage market. The greater the demand for mortgage-backed bonds, the more likely lenders are to make new loans.
WILSON: That will make it easier for Americans to get homes.
The Federal Reserve says it’s keeping an eye on what the banks are buying. In some cases it’s even stepping in to make sure banks manage the risk properly.
In New York, I’m Amy Scott for Marketplace.
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