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Op-Ed: Will the Real Toxic Assets Please Stand Up?


Credit card, commercial real estate losses have yet to be fully felt.

Editor's Note: James Quinn is a senior director of strategic planning for a major university. James has held high-level financial positions with a retailer, homebuilder and a university in his 22-year career. He can be found online at

Which Assets Are Toxic?

In the last 9 years, US financial institutions got extremely creative with their financial "products." They were encouraged by Federal Reserve Chairman Alan Greenspan, and by then-president George Bush, both proclaiming the benefits of free-market capitalism.

Watching over the creative bankers was the eagle-eyed SEC. Fresh off the Enron and WorldCom scandals, the agency decided the investment bankers should be allowed to leverage their assets 30 to 1, rather than 12 to 1, which had been in place for decades.

The final piece of the puzzle: Obtaining AAA ratings for these new "products" from Moody's (MCO) and S&P. Their CEOs, eager for a little excitement -- and maybe big bonuses and stock options -- decided to jump headfirst into rating the new indecipherable products. Surprisingly, after being paid billions in fees, the rating agencies provided AAA ratings across the board to all of the new investment products.

The Wall Street geniuses peddled MBSs, CDSs and CDOs to all and sundry. With AAA ratings, no one bothered to conduct due diligence, nor to understand what could go wrong. The amount of derivatives outstanding rocketed from $40 trillion in 2000 to $684 trillion in 2008. It's been reported that 80% of all credit default swaps outstanding in 2008 were speculative; $440 billion of those were held by AIG (AIG). Wall Street had become a casino.

The economy -- juiced by low interest rates, mortgages, subprime loans, and consumers sucking $3 trillion in equity from their ever-increasing home values -- appeared unstoppable. Home values doubled in 5 years. The Dow Jones reached 14,000 in October 2007, As the economy was sailing along at 70 miles per hour, it suddenly hit a wall: A Bear Stearns hedge fund blew up.

Congress, the Treasury, the Federal Reserve, and 2 presidents have tried to convince Americans that the financial system is no longer infected with toxic assets. They have committed $11.6 trillion of your tax dollars to make the system function again. They can pour another $11 trillion into the system, and probably will, but the trust in gone. Enough is enough.

We all know what's happened in the last 18 months. But we still don't know what toxic assets remain in the system. The banks' balance sheets are a black box: They have billions of dollars in off-balance sheet "assets," and the commercial real-estate market is just starting to collapse. Banks were handing out construction and land development loans between 2004 and 2007 at twice the rate of residential mortgage loans; these will begin to go bad late in 2009 and through 2010.

Bad mortgage loans have been the primary driver of the financial crisis so far. But residential mortgages make up only 26% of bank loan portfolios; commercial real estate and construction loans total 40 percent of bank loan portfolios.

The credit-card losses are confined to a few major players. Citigroup (C), Bank of America (BAC), American Express (AXP) and Capital One (COF) may soon be in even more trouble: US credit-card defaults rose in February to their highest level in at least 20 years. AmEx, the largest US charge-card operator by sales volume, said its net charge-off rate -- those debts companies believe they will never be able to collect -- rose to 8.7% in February from 8.3% in January.

Analysts estimate credit card charge-offs could climb to between 9 and 10% this year; losses could total $70 billion to $75 billion. Meredith Whitney estimates that Americans' credit card lines will be cut by $2.7 trillion, or 50%, by the end of 2010. There will be another crescendo of ARM resets in 2010 and 2011. Banks will almost certainly need to ask for more taxpayer money to shore up their balance sheets in 2010.
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No positions in stocks mentioned.

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