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, "the toxic securities in question are not homogeneous."[1]. One example would be a credit default swap 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.[2]
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.[3]