What is Toxic Waste?
Toxic waste is an idiomatic expression referring to high-risk assets with reputedly low liquidity.
How Does Toxic Waste Work?
Named in reference to the hazardous byproducts of industrial processes, toxic waste frequently describes the riskiest tranches of many collateralized mortgage obligation mortgage obligations (CMOs). In an effort to provide investors with lower-risk issues of CMOs, issuers (mainly banks) inadvertently create toxic waste classes (tranches) which bear the risk eliminated from the former. Issuers accomplish this by packaging together remaining undesirable high-risk mortgage receivables. Such receivables bear little, if any, liquidity, and there is often little information available to investors.
Why Does Toxic Waste Matter?
Toxic waste tranches are discernible by their heavily-discounted face value and low transparency vis-a-vis their composition. Investors avoid toxic waste securities because, similar to the environmental impact of actual toxic waste, the securities can be detrimental to the financial viability of a portfolio.