Coming to terms | Toxic assets

For months, banks have been described as needing to be bailed out because they're struggling under the weight of "toxic assets." What makes an asset "toxic," and why are they causing so much grief?

Most bank assets consist of mortgages, car loans, credit-card balances and other loans. Banks can either keep such assets on their books, in which case they're supposed to be valued at market prices, or bundle them up into bonds and sell them off, a process called securitization.

Securitizing mortgages became especially widespread in recent years. Hundreds or thousands of home loans were pooled, sliced up in complicated ways and used to back bonds. That allowed banks to keep fewer loans on their books and more cash, which they used to make new loans.

That seemed to work well until late 2007, when bond investors realized that many people who'd taken out subprime mortgages, pay-option mortgages and other "innovative" home loans were falling behind or defaulting on them. That meant the bonds backed by those mortgages were worth less — sometimes a lot less — than what the investors had paid for them.

But because of the complex slicing and dicing, no one could tell how compromised any particular mortgage-backed bond was, so investors began shunning them all. (Similar fears eroded the market for bonds backed by other kinds of debt.)

Banks now are stuck with loans and securities they can't sell. Since there's no market for them, and hence no market price, banks have had to repeatedly write down their value — weakening their overall financial structure and forcing them to seek new capital. And until their own finances have stabilized, banks now are reluctant to loan money to anyone.

Drew DeSilver, Seattle Times business reporter