The Federal Reserve is stepping into the economic breach

April 17, 2009 - PRLog -- The Federal Reserve created the Term Asset-backed Securities Loan Facility (TALF) to lend up to $200.00 billion (which may be increased up to $1 trillion) to eligible private borrowers, such as hedge funds, private equity firms, and mutual funds, in order to finance investments in eligible asset backed securities (ABS). The ABS are AAA-rated securities backed by new and recently originated auto loans, student loans, credit card loans, and small business loans. Under the TALF, the Fed will offer eligible borrowers three year loans in an amount equal to the value of the eligible ABS purchased, or owned by the borrower, less a collateral haircut of between 5-16% of their value, depending on their type and expected life. The TALF loans must be fully secured by the ABS financed by the loan. The interest rate on TALF loans will equal the three-year LIBOR rate plus 100 basis points for fixed-rate ABS, and one-month LIBOR plus 100 basis points for floating-rate ABS.

Other than loans secured by ABS, which are backed by student loans guaranteed by the Federal government, and ABS, which are backed by small business loans guaranteed by the SBA—both of which will have lower interest rates—they will be offered at a significant discount from current market rates. In addition, borrowers must pay an administrative fee equal to 5 basis points of the loan amount. The highly discounted selling price of these loans (about 1% over LIBOR) allows the investor to buy packages of loans that were originally spread at 5% over LIBOR, and to do so, with little up-front investment. Over 70% of jobs are created by small business, and federal guaranteeing of loans in this area is designed to be a needed first step in regard to creating at least some liquidity. The Fed anticipates the program will be expanded to include commercial real estate, leases for commercial and government vehicles, well as agricultural and heavy-equipment loans and leases.

The TALF program is designed to be an important, but just preliminary enabling of what the paradigm of a secondary market can produce. The larger action begins with the Public-Private Investment Program (PPIP), and involves employing the same general means of TALF to both commercial and private, mortgage-backed, collateralized debt obligations (MBCDOs). In fact, the current plan is to grant PPIP investors certain access to TALF funding, as well. Of import, is that all this will operate on an international scale, where the market for investment has no borders. This is how the global economy came tumbling down, and is how it will force-feed its way back up. Only this time, it will be under a regulatory and transparent tent, and despite the former practice of Wall Street—lobbying for more deregulation—this time they will see and experience, first-hand, the devastation that it has caused. If Wall Street had tempered their greed with even a soupcon of this understanding, at the start, they would have thought twice about becoming enamored with the prospect of deregulation. The “whole” is, not only greater than the “parts,” it fuses, and fissions, the atomic structure of the “parts.”

A rather tough lesson to be learned!

Unlike the S&L crisis in the late 1980s, the underlying assets of the MBCDOs have substance. There are actual homes and commercial real estate that exist, whose potential value, while subject to supply and demand, is real. They are more of a longer term investment, and that is why the permanent capital of giant Funds is being courted. The junk bonds were never worth the paper they were written on, and that is one of the reasons why having a Resolution Trust Corporation solution to the current problem is undoable. The idea that it makes more sense to just let the failed banks go under, is even more illogical. The ones that have been hit the worst are the biggest, and having all the pension-funds and IRAs go up in smoke, along with the shareholders, is a solution without rational basis to indulge. And it is not just American investment in these banks. Imagine what the Market’s response would be to Citigroup, Bank of America, and Wells Fargo, showing up in Bankruptcy Court at the same time. Imagine what China’s response would be. They pull out of U.S. Treasuries, and you can kiss the “red,” “white,” and “blue” goodbye. Well, maybe not the “red.” It should also be noted, that we cannot just let about $2 trillion in mortgage-backed securities go south. The PPIP is designed to use the underlying value of same to keep trading, so that we can remove stagnant (toxic) assets off the balance sheets of the banks, and thus, stimulate liquidity. Furthermore, the Government is a 50/50 partner in PPIP, and thus provides the not unreasonable basis for eventually recapturing the potential worth of the underlying assets, which can be used to help repay the Government for the loans which the bailouts have necessitated. Even if the Government were to buy up the toxic assets, who would price them? Who would set up a government-run insurance agency to try and stimulate the discounted selling of these assets to investors. The only way to create a market for them, is to have private capital do what they do best: make a market for them. And the only way to finance the investment capital needed to do this, is to provide leveraged capital, and a floor on potential losses. The initial response to PPIP has been positive. Giant bond funds, like Blackrock, Pimco, and The Carlyle Group, have assured their participation, and the Markets have risen significantly. The favorable response to regulatory oversight of all Market activity, agreed upon at the G-20 meeting, reflects the cooperative efforts of nations facing a far more interconnected wiring of economic concern.

The significant aspect of these programs is that they are directed at the source: the toxic assets which have frozen the life’s blood of business – “credit.” In this regard, perhaps the public should be alarmed by not only the wave of bankruptcies, but the speed at which they have occurred. The current programs that have been put in place, within the umbrella of regulatory oversight, will noticeably change the playing field, in a proactive means, and way. As to financial management, today’s credit executive must continue to balance the consequences of deciding whether to “cut and run,” or provide ongoing support to troubled customers.

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