The Return of Toxie

NPR has a new story – The Return of Toxie. For those not in the know, they bought a portion of a mortgage they assumed was a toxic asset and followed it into the ground. It was pretty hilarious to read – If I remember correctly it was a B rated bond but had so few details on what the applicant actually did for a living that it was hard to tease out if s/he did anything at all.

Predictably, the loan went south.

Now, for people following the story, it looked like these guys lost their cash and that was the end of it. They put $1000 in, they could have gotten $75,000 out at the end of the 40 year term, but since the borrower never paid they were left with $500. Here’s where things get hilarious – some lawyer somewhere decided to sue the loan originator (Bank of America) by saying the loan wasn’t properly vetted so they misrepresented the investment. OK that’s reasonable and it’s what the SEC does by itself all day every day.

What makes this really neat is the potential this has on the market. They’re only in $1000. There’s people into this several thousand. There’s people into this tens of thousands. Because of the way mortgages were bundled, this is a multi-million dollar automatic class action lawsuit.

If you remember the head scratcher that was the bank bailout, it’s not like anything actually happened. The houses still existed, some notion of money changed hands, and the banks stayed afloat. Where did the money go? Where did the assets go? Well, the banks now have a pile of houses on the books, but for the most part they’re no-ones hoses with the government buying the guarantees to the toxic assets. In other words, the banks got what amounted to free money by selling these assets to the government at face value but if you had the script, you lost your money. Too bad. The government doesn’t bail you out.

This is a compelling argument because it means that people can (and should) seek redress from the issuer who we already knew the loans were toxic when they issued them and they already made the argument in court. Framed as a request for bailout money from the government, this now becomes a liability to the banks when the investors read and use it against them.

Now, the BIG QUESTION… Assuming these suits are successful, and I think they will be, will we have another round of bank bailouts or should we do like we should have done in the first place – let the smaller banks chop up the bigger banks assets and let the bigger banks go through chapter 11 like they should have in the first place?