The U.S. Treasury’s much-maligned(TALF) and its new “prequel,” the (PPIP) have been viewed by the markets and skeptical prospective participants as merely a price discovery mechanism which, with a lot of luck, might create a floor under toxic security prices.
Now, with markets showing signs of life, and relief from dreaded mark-to-market accounting rules passed yesterday (Thursday), the intended price discovery floor may actually become a foundation for climbing out of the credit crisis. But will it work?
How strong the foundation will be, on whose backs it will be built, who will be able to climb out of trouble as a result of the programs, and who will reap any potential windfall profits are all part of the ongoing dialogue surrounding the programs.
The TALF was conceived last November as a means to reinvigorate the securitization markets, which are an integral part of what is known as the shadow banking system. Consumer loans, for example, are packaged into securities and sold to investors. When investors buy these securities the money they pay for them goes back to the originators of the loans, who have new money to make more loans. The process is replayed over and over and the result is a massive revolving line of credit for borrowers seeking loans for cars, schools, mortgages, business loans, credit cards, etc. When the credit crisis hit, the music stopped and the securitization markets ground to a dead standstill.
Last year, according to the American Securitization Forum, the volume of loan securitization worldwide plummeted by $2.4 trillion from 2006 levels. The Forum, an industry trade group, estimates nearly half of all consumer loans depend on securitization.
The TALF is supposed to push banks and other finance companies to keep making new loans. To entice sidelined investors to buy these new securities, the government is offering buyers cheap financing and only requiring them to pay a small portion of the purchase price up front.
At the same time, the U.S. Federal Reserve and Treasury have been grappling with what to do about toxic assets on the balance sheets of banks, insurance companies, pension funds and other systemically important financial intermediaries. In order to reinvigorate last year’s Treasury plan, the original Troubled Asset Relief Program (TARP), conceived by former Treasury Secretary Henry Paulson, current Treasury Secretary Timothy F. Geithner wants the private sector to partner with the government to help remove toxic assets from exposed banks and financial intermediaries.
I’m calling this new PPIP, Public-Private Investment Program, a prequel because although it’s been recently trotted out, it is really the overarching idea that underlies the TALF. Just like the TALF, which provides private investors borrowed money from the Fed and Treasury to buy new consumer loan security pools, the idea of PPIP is that private investors are backed by the government with loans and leverage to buy toxic assets from banks. But, in a belated testament to the depth of our current problems, toxic assets may now include “legacy loans,” or existing loans and other underwater financial instruments clogging the balance sheets of lending and investing institutions.
Originally, the TALF and PPIP ideas were viewed as a means to get investors to actually bid on new securities and old toxic assets, thus providing a price discovery mechanism by which investors might have some measure of value to start trading these securities again.
But, while nothing was happening with PPIP or TALF programs, and not a single transaction took place, something else was happening in the markets and with investors. Perceptions began to change about the duration of the recession, the vast amount of stimulus being thrown at the world’s broken economies, and the trillions of dollars on the sidelines waiting for an opportunity to be put back to work. Although the current recession has definitely not reached bottom, and there will likely to be many more painful months ahead, markets are leading investors to revisit the potential effects of TALF and PPIPs.
The New York Federal Reserve Bank received nearly $5 billion in loan requests from investors interested in buying asset-backed securities, according to a March 19 report from MarketWatch.
“The New York Federal Reserve Bank said late Thursday it had received $4.7 billion in loan requests from investors seeking to access central bank funding to buy asset-backed securities,” the report said. “In the first round of its Term Asset-Backed Securities Loan Facility, or TALF, it received $1.9 billion in loan requests linked to auto-loan securitizations and $2.8 billion in credit-card related loan requests. It did not receive any requests for loans to buy student-loan or small-business securitizations.”
Besides shifting perceptions, there’s the new concrete building block that investors are looking at. Under tremendous pressure, Financial Accounting Standards Board (FASB) voted yesterday to relax mark-to-market rules that force companies to take impairment charges on their “available-for-sale” investments. This was icing on the cake.
The magnatidude of this event cannot be understated. The ramifications it will have will bear directly on the Treasury’s PPIP, TALF and TARP operations and all the markets.
And while in the long run we need to return to mark-to-market, and we eventually will, in the near term, the relief it will provide devastated banks and other financial institutions and investment companies give the government more time to address and fix capital deficiencies, and give the Federal Deposit Insurance Corp. (FDIC) more time to better systematically close insolvent institutions.
If you’re wondering what this has to do with TALF and PPIP and building a foundation, it has everything to do with these programs:
First, appropriate controversy should exist and open dialogue should persist about who gets taxpayer loans and be allowed insane leverage to buy TALF and PPIP assets.
I, for one, don’t see how reliance on leveraged purchases with taxpayer money by the same private equity firms who bankrupted Linen N’ Things Center Inc., Mervyn’s, Chrysler LLC, and more than half of all the bankrupt companies listed by S&P in 2008, would create any comfort for taxpayers or investors. The same goes for the hedge funds that leveraged themselves, lost hundreds of billions of dollars and spread the plague of credit default swaps around the world.
What about average investors? Where are the advocates for household investors who should be calling for preferential tax treatment on any gains or losses and cheap government borrowing and non-recourse loans for the rest of us who would like to make some money off these PPIP and TALF programs, instead of watching all the advantages go to the good old boy network.
Just maybe, since the U.S. savings rate has gone from negative 0.7% to nearly 7%, which is being deposited in our banks, and since banks have access to relatively cheap TARP capital – and if they don’t have to mark down their impaired inventories any more –we’ve actually found a floor.
Now, if we have a floor, what will any additional buying power in the form of PPIP and TALF programs mean for existing assets? In my opinion, they will start to get bid up. The floor becomes a foundation and we have some breathing room to try and climb out of the hole we’re in. This is not the moment to cede to private equity firms and hedge funds the potential upside that exists with any recovery.
If we have established a floor and start to build a foundation, it doesn’t mean the work is over. We will need to make sure the foundation is broad and not reliant upon the same “too-big-to-fail” institutions, the same leveraged swashbuckling greedy usurpers, or the rotten pillars of government legislating a brighter future for their masters and themselves when they are done milking the hardworking and proud men and women of this great country.
However, a foundation could mean that the fear that massive Treasury debt will sink the dollar and ignite hellfire inflation may not be in our immediate future. And it just might mean that we won’t have to keep the printing presses rolling to further stimulate the economy, because change has already happened. America is on the move.
News and Related Story Links:
- Treasury Department:
- Money Morning:
Stock Markets Move Past Gloom and Doom in Anticipation of the U.S. Economy’s Recovery
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
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