Toxic debt and subprime crisis

What they are
What are usually called "toxic debts" or "toxic assets" or "illiquid assets" are American investment instruments (securities and derivatives) which are backed by subprime mortgage loans.
Those loans were made to buy overpriced houses with no or little downpayments, to people with too low incomes and usually at progressive interest rates.
Those overleveraged loans were speculations on a continuous rise of US real estate prices. But that rise was actually a speculative bubble that reverted into a crash in 2007, when many of those house owners found themselves unable to bear the interest payments and faced foreclosure.
The value of those assets is now considered highly dubious and they have become illiquid as nobody wanted to buy them anymore, even at a large discount.

The effects
Those assets were repackaged by the lenders so as to look like bona fide securities. Those financial instruments were bought extensively by banks, funds, insurance companies and other institutions. Their total amount (at their issuing price) is not fully known but said to be between one and two trillion US dollars.

Those toxic instruments have been the main damaging factor in the now famous 2007 - 2008 "Subprime crisis". They have put in danger various prominent investment banks and other institutions which carry them in their portfolio.
Some already went bankrupt (Bear Stearns, AIG, Lehman Brothers...) or taken over (Fannie Mae, Freddy Mac, Merril Lynch...). The damage extended to institutions outside the US which had to do huge write-offs and launch important recapitalization operations

The rescue offer
A 700 hundred bullion US dollar plan devised by the US Treasury chief, Henri Paulson, was enacted in September 2008 with the objective to buy those debts to those institutions so as to avoid a world financial "systemic crisis". Those assets will be bought, held and managed by a specific US Government-owned federal fund. Also that fund will buy shares of some of the banks involved.

The countries of the European Union decided similar measures, completed by government guarantees on bank customer deposits.

* To understand better: what is a "systemic crisis"?
A financial "systemic crisis" is when the collapse of an institution brings the collapse or another one, then of another one still, and so on until most of them collapse.
This cascade of failures is a "domino effect" due to:
* Either emotional contagion
The clients, depositors or holders, consider that other institutions are as risky as the one that failed and take their money back, (the typical example is a "bank run").

* And/or a mechanical effet due to cross-interests between financial institutions:
Some institutions with money deposited in the first institution suffer a heavy loss and become ruined on their turn. This brings the collapse of other ones for the same reason, and so on...




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