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The Term Asset Backed Securities Loan Facility (TALF) program has succeeded in reviving the consumer loan-backed market and may even return a profit for the Federal Reserve, according to William Dudley, one of the main architects of the facility.
In an interview with Dow Jones Newswires, Dudley, the president and chief executive officer of the Federal Reserve Bank of New York, said that the TALF program has reignited the market for securities backed by loans on vehicles and credit-card debt.
TALF was launched by the Fed to entice buyers to buy new bonds backed by auto and student loans. At the time, investors were reluctant to purchase securities backed by shaky collateral, fearing they would lose their entire investment.
The market picked up after the central bank stepped in because the government guarantees meant investors could walk away from bad loans and lose only part of the capital they had invested.
A typical example of the process would work like this: The Federal Deposit Insurance Corp. (FDIC) auctions a package of loans with a face value of $100. Because the collateral may no longer be worth $100, the winning investor bids only $60. The FDIC uses TALF funds to fully guarantee a $51 loan to the private investor.
The investor would put up $4.50 and the Treasury Department matches that amount, bringing the total loan to the $60 bid price. The private investor must pay back the $51 loan over time, but if the loan fails entirely, then the private investor loses only his $4.50. The Treasury loses $4.50 and the FDIC loses $51 since TALF provides a 100% guarantee on the loan.
But even with these generous lending terms, the program is "highly likely" to make a profit, Dudley said, even though he declined to quantify the amount of profit.
A recent report by the U.S. Government Accountability Office (GAO) said the Treasury should strengthen data needed to track the management and sale of assets TALF borrowers might surrender to the government. But Dudley maintained that by limiting the program to triple-A rated securities and requiring borrowers to put up some capital of their own, the bank is "very comfortable" with its credit risk on TALF. Also, prices are unlikely to fall as low as they were in the middle of the financial crisis. Even if they did, the Fed would no longer be forced to sell the assets on-the-cheap but could simply hold them until the market rebounds.Even though it got off to a slow start, TALF has issued more than $100 billion in eligible securities since the program launched last March. It was initially supposed to draw up to $200 billion in funding from the Troubled Asset Relief Program (TARP), which backstops the program. But residential mortgage-backed securities were not included in the program, limiting TALF's exposure."It's a smaller program than was anticipated," Dudley said. "The reason the program is smaller than we initially thought is because the market normalized faster than we thought."
Borrowers have been repaying TALF loans and "they can actually go out in the marketplace and get financing elsewhere instead of using TALF," he added.The market has now stabilized to the point where the Fed isn't considering extending the consumer loan-backed and commercial mortgage-backed securities portion of TALF past the current expiration date of March 31.
The case for extending TALF has "diminished," Dudley said, noting TALF was "the most innovative liquidity program."
It was "difficult because we had to develop it from scratch. It is definitely one of my favorites."
News & Related Story Links:
Term Asset Federal Loan Facility
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Fed's Dudley Says TALF Could Generate Profits
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TARP, PIPP, TALF, FRB, FDIC, EESA – An Expensive Alphabet
Troubled Asset Relief Program