Toxic Debts

Posted in Finance, Accounting and Economics Terms, Total Reads: 633
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Definition: Toxic Debts

Toxic Debt is a debt which has a very little chance of being paid back with its interest. The term was widely used during the sub-prime crisis of the late 2000s.


Toxic debt is caused primarily due to assets which were assumed to be quite valuable at the time of issuing the debt but have suffered a drastic fall in their prices or do not have a functioning market where they can be sold satisfactorily. Toxic debts can also arise out of unjustified and improperly high credit ratings giving the impression that a debt is more secure than it actually is. Going by this, a junk bond cannot be termed as a toxic debt as the risk associated with it is already known.


Example: In case a homeowner defaults on a loan, the home itself could be resold to recover the losses. However, in case of an economic slowdown when the price of property has fallen drastically, there is no collateral to restore the debt holder resulting in a toxic debt.

 

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