Capital Markets

The Fed Launches Another Lifeboat

The government plans to bailout asset-backed securities and housing debt.
Stephen TaubNovember 25, 2008

The government is now giving bailout money to companies that provide credit cards, student loans and car loans. The Federal Reserve Board on Tuesday announced the creation of the Term Asset-Backed Securities Loan Facility (TALF), a facility that will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.

The U.S. Treasury Department — under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 — will provide $20 billion of credit protection to the Federal Reserve Board of New York in connection with TALF.

The TALF program is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads, the Fed said in its announcement.

Separately, the central bank also announced that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises that provide mortgages to homeowners and small businesses. The GSEs include Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The program also is involved in purchasing the direct obligations of mortgage-backed securities (MBS) supported by Fannie Mae, Freddie Mac, and Ginnie Mae, the Government National Mortgage Association.

“This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally,” the Fed continued in its statement.

Investors seemed to like the twin announcements. Stock futures were bid up — after signaling a down open — to much higher levels on the heels of two straight huge gains, which some observers say indicates that Wall Street continues to embrace stimulus plans over fiscal conservatism.

Under TALF, the Federal Reserve Bank of New York will lend an amount equal to the market value of the ABS, less a haircut, and will be secured at all times by the ABS. The haircut, or the market maker’s ultra thin margin, is currently unknown. The Fed noted that new issuance of ABS declined precipitously in September and came to a halt in October. At the same time, interest rate spreads on AAA-rated tranches of ABS soared to levels well outside the range of historical experience, reflecting unusually high risk premiums.

The ABS markets historically have funded a substantial share of consumer credit and Small Business Administration-guaranteed loans. “Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity,” it explained.

As for the program involving the GSEs, the Fed elaborated that purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions and will begin next week.

Purchases of up to $500 billion in MBS will be conducted by asset managers selected under a competitive process with a goal of beginning these purchases before year-end. Purchases of both direct obligations and MBS are expected to take place over several quarters.

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