Are toxic assets really toxic?

Accountants record. They don’t analyze. There isn’t a right number and a wrong number. There are just useful numbers and useless numbers. In her book Dear Mr. Buffett, Janet Tavakoli quotes an email from Warren Buffett:

“I’ve looked at the prospectuses, and they are not easy to read. If you want to understand the deal you’d have to read around 750,000 pages of documents.”

A lot of people make the argument that these assets are not toxic at some prices. Theoretically, that’s true. If there’s value in an asset – at some deep discount to par – a high-risk asset can become a low-risk investment.These toxic assets are “meta-bets”. A low price is little help if there is inadequate cash flow or collateral built into the asset. A low price can’t fix an inherent flaw in an asset. If the cash flow generating potential of the asset is almost non-existent, the asset is essentially worthless.

A lot of these toxic assets were similarly structured. They were built to fail.A bad house is a good value at some price. A risky mortgage is a good value at some price. But “meta-bets” are trickier. They can suffer from the same sort of problem Buffett described with the very worst junk bonds – you can actually take a good asset, with good cash flows and then put so much debt on top of it that the only way you can fix the problem is by restructuring the debt. In such cases, a low price is no longer enough. The terms are the problem.