Friday, December 19, 2008

TALF: Quicker, easier, more seductive

The Fed has expanded the Term Asset-Backed Loan Facility (TALF), which AI first discussed here. Here is the quick recap of the facility.

1) Fed will loan funds for purchase of recently issued ABS. This was clarified to mean ABS issued after January 1, 2009 made up of loans no older than October 2007. The ABS must be rated AAA, and be made up of student loans, auto loans, small business loans, or credit cards.

2) Loans will be non-recourse and not marked-to-market. The borrower will not have to deal with margin calls due to price declines.

3) The loan term will be up to 3-years, originally was only 1 year. That is extremely positive for the potential success of this program. See below.

4) The loan rate will be set at "yield spreads higher than in more normal market conditions but lower than in the highly illiquid market conditions that have prevailed during the recent credit market turmoil." In other words, lower than the rate paid on the asset.

So what has the Fed done here? Created an easy arbitrage. All investors have to do is do accurate credit work, and this is a guaranteed profit. Note that the 3-year term seals this thing. 3-years is basically the entire life span of most eligible collateral, so it eliminates the last thing an investor needed to worry about. Given a 1-year term, investors would have worried that the end of 1-year, new financing might not be available. But by the end of 3-years, the asset will be all but gone.

Also through this facility, the Fed can really control consumer lending rates. The rate on newly issued AAA ABS will be stuck at a level slightly higher than the Fed's lending rate. Banks which are currently hoarding cash will fall over themselves to buy ABS and pledge them into this facility.

Now don't read this as especially bullish for the overall economy. I still see this as a facility intended to aide in quantitative easing, and not a "fix" for the recession. Or put another way, a means of preventing the economy from getting still worse. But as far as ABS go? Should get that market rolling again.


  1. I understand your logic in terms of the Fed's purchase of these assets liquifying those currently holding the paper and the point about the arbitrage opportunity. But how is this going to get the private buyers of asset backed securities back into the market. Or did I misunderstand your last point.

    I agree that this will give the Fed a great deal of control over consumer lending rates. Do we really want to be there? Government control of prices has rarely seemed to work well.

  2. Something I don't quite understand... doesn't someone still need to buy the lower quality tranches in order for this to encourage lending?

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  4. "But how is this going to get the private buyers of asset backed securities back into the market."

    Does that matter right now? The idea is to faciliate a trade between willing buyers wanting credit and willing sellers. If the feds can establish low cost credit, confidance can be built that a bottom is forming. People will then want to buy these securities in a more normal manner.

    If the feds expand the eligibility of borrowers they must establish a bottom sooner or later with a low interest and none recourse program.

    If this then facilitates a "normalisation" of world trade where all countries are supporting the feds then we are heading in the right direction for adjustments to be worked thru.


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