The Fed seeks to launch another bubble
Richard Moore
Under the program, the Fed will lend to investors who acquire new securities backed byauto loans, credit card balances, student loans and small-business loans at rates ranging from roughly 1.5 percent to 3 percent.
Depending on the type of security they are borrowing against, investors will be able to borrow 84 percent to 95 percent of the face value of the bonds. Investors would not be liable for any losses beyond the 5 percent to 16 percent equity that they retain in the investment.
http://www.nytimes.com/2009/02/20/business/20lend.html
Credit cards, home equity lines, student loans, car financing: none come cheaply or easily in these credit-tight times. The banks, the refrain goes, just will not lend money. But it is not simply the banks that are the problem. It is also what lies behind them. Largely hidden from view is a vast financial system that serves as the banker to the banks. And, like many lenders, this system is in deep trouble. The question is how to fix it. Most banks no longer hold the loans they make, content to collect interest until the debt comes due. Instead, the loans are bundled into securities that are sold to investors, a process known as securitization. But the securitization markets broke down last summer after investors suffered steep losses on these investments. So banks and other finance companies can no longer shift loans off their books easily, throttling their ability to lend. The result has been a drastic contraction of the amount of credit available throughout the economy. By one estimate, as much as $1.9 trillion of lending capacity — the rough equivalent of half of all the money borrowed by businesses and consumers in 2007, before the recession struck — has been sucked out of the system. Banking chiefs, who have come under sharp criticism for not making more loans even as they have accepted billions of taxpayer dollars to prop themselves up, say it is the markets, not the banks, that are squeezing American borrowers. The Obama administration hopes to jump-start this crucial machinery by effectively subsidizing the profits of big private investment firms in the bond markets. The Treasury Department and the Federal Reserve plan to spend as much as $1 trillion to provide low-cost loans and guarantees to hedge funds and private equity firms that buy securities backed by consumer and business loans. The Fed is expected to start the first phase of the program, which will provide $200 billion in loans to investors, in early March. But analysts question whether this approach will be enough to unlock the credit that the economy needs to pull out of a deepening recession. Some worry it may benefit only select investors at taxpayer expense. The program also does not try to change securitization practices that, many investors say, spread risks throughout the world and destroyed financial institutions. Policy makers acknowledge that for now, fixing credit ratings, reducing conflicts of interest and improving disclosure can wait. Under the program, the Fed will lend to investors who acquire new securities backed by auto loans, credit card balances, student loans and small-business loans at rates ranging from roughly 1.5 percent to 3 percent. Depending on the type of security they are borrowing against, investors will be able to borrow 84 percent to 95 percent of the face value of the bonds. Investors would not be liable for any losses beyond the 5 percent to 16 percent equity that they retain in the investment. In the initial phase, the Treasury will provide $20 billion and the Fed will provide $180 billion. Treasury Secretary Timothy F. Geithner said last week that the Treasury could increase its commitment to $100 billion to allow the Fed to lend up to $1 trillion. Investors and economists said that the effort could help restore some lending, but added that it might not be big enough to fully replace all or most of what has been lost, especially if the nation’s biggest banks are not restored to health. “The gap to be made up is huge,” said Hyun Song Shin, an economist at Princeton who has written extensively about the shadow banking system. “Ideally, you would like the commercial banking sector to step up and take charge of the train but they are in no position to do that because they are undercapitalized.” The market for new securities backed by mortgages and other types of loans has collapsed. Last year, investors bought $313.9 billion of these securities, down from $1.6 trillion in 2007 and $2.1 trillion in 2006, according to Dealogic. Last month, banks issued just $1.6 billion worth of such deals. Banks and finance companies are holding more loans on their books, but their ability to do so has been eroding as losses rise on their existing assets. Since October, banks’ holdings of loans and leases have shrunk by 2 percent, to $7.1 trillion. In the mortgage market, banks own just one-third of all loans, down from half as recently as 1990. Investors and bankers say the Treasury program, called the Term Asset-Backed Securities Loan Facility, or TALF, could help unclog vital channels of capital, but they add that it is hard to know how big an impact it will have. For one thing, the Fed will make loans against only triple-A rated securities, not lower-rated bonds, which are first to suffer losses when borrowers default on loans. That will not help banks sell junior bonds, which many investors have shunned because of fears that losses would rise as the economy worsened, said Thomas H. Atteberry, a partner at First Pacific Advisors, an investment firm based in Los Angeles. “It’s probably a step forward but it may only be a baby step forward,” said Mr. Atteberry, who does not plan to use the TALF. Jerry Marlatt, a partner at the law firm of Clifford Chance who specializes in securitization, said that lenders using the TALF would be willing to retain more of the risk associated with loans on their own books to get deals done. That should help ensure that lenders make better-quality loans in the future, because they will be liable for most of the losses. Simon Johnson, an economics professor at the Massachusetts Institute of Technology and a former chief economist at theInternational Monetary Fund, said many people might take a dim view of the TALF program because it provided government subsidies to investors like hedge funds. Investors who borrow from the Fed could enjoy annual returns of 20 percent or more. “The TALF,” he said, “raises a lot of questions.”U.S. Tries a Trillion-Dollar Key for Locked Lending