Toxic security
Encyclopedia
Toxic Security is the name applied during the aftermath of the subprime meltdown to financial instruments which cannot be readily identified as an asset or a liability. According to George Soros
George Soros
George Soros is a Hungarian-American business magnate, investor, philosopher, and philanthropist. He is the chairman of Soros Fund Management. Soros supports progressive-liberal causes...

, "the toxic securities in question are not homogeneous.". One example would be a credit default swap
Credit default swap
A credit default swap is similar to a traditional insurance policy, in as much as it obliges the seller of the CDS to compensate the buyer in the event of loan default...

 that entitles the holder to a regular stream of small payments but obliges the holder to make a large payment if a specified event occurs. John Gapper describes one such instrument, a "tail risk" swap:

...[S]tructured finance gave banks and others more chances to take on “tail risk”. This is an insurance-like trading strategy: one institution writes swaps or options that provide it with regular payments in exchange for taking another’s risk of default. In most cases, this produces profits, but occasionally it is disastrous.


The right to receive a stream of payments is accounted for as an asset. The obligation to make a payment is accounted for as a liability. In the case of a credit default swap, the number and amount of payments in and out is subject to an undetermined risk.

The net value of the expected cash flows is calculable by reference to a model, but the calculations require a degree of confidence in the probabilities of the named event occurring which may be unwarranted. "There is no doubt there could be disagreement on what the fair value for these securities is,” said Lawrence Levine, director at RSM McGladrey
RSM McGladrey
McGladrey is the 5th largest accounting firm in the United States by revenue and a member of the global accounting network RSM International.The firm has more than 8,000 employees across 85 offices nationwide providing assurance, tax, and consulting services...

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