Banks Are Buying Toxic Assets, But Why?

Bank of America (BAC) and Citigroup (C) have been actively buying toxic mortgage assets, according to the New York Post. And they are placing higher bids than other would-be buyers.

That’s right, these beleaguered banks are buying the very types of assets that are plaguing their balance sheets.

Much of the distressed debt has not been selling because nobody knows how to value it. Furthermore, the major banks are fearful that if they sell the toxic assets in the open market, they will be forced to take additional, large write-offs. Such write-offs would adversely effect the various ratios used to measure their financial health.

Why are BAC and C doing this? A spokesman for BAC told the newspaper that they are trying to “increase liquidity in the mortgage market allowing people to buy a home”.

Another possibility could be that the two companies are attempting to raise the price of the distressed debt. The goal would be to raise prices and thereby reduce the amount of write-offs they could potentially be facing.

There have been reports of private investors who are willing to buy the toxic assets, but have been rebuffed by the banks. The reason is that the banks don’t like the price.

The new plan proposed by Treasury Secretary Tim Geithner poses the same risk. It will only work if investors and the banks can agree on a price. If the banks refuse to sell at a cheap enough price, the current problem will continue.

Investors need to remain extremely cautious. Bank stocks are trading on daily sentiment, and neither fundamental nor technical analysis is working right now. At some point there will be buying opportunities in this sector, but right now, the short-term risk remains extremely high.

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