During his “Semiannual Monetary Policy Report” to Congress in late February, Federal Reserve chairman Ben Bernanke said that “there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.” But he stressed that this pattern will materialize if, and only if, actions taken by the administration, Congress, and the Federal Reserve “are successful in restoring some measure of financial stability.” Aye, there’s the rub!
Bernanke’s comments came two weeks after Treasury secretary Timothy Geithner presented the outline of the administration’s Financial Stability Plan to the world. It’s fair to say that financial markets were deeply disappointed and highly skeptical of what Geithner had to say, particularly with respect to components dealing with fresh rounds of capital injections into banks and an ill-defined public/private effort to get toxic assets off of banks’ balance sheets.
Bring on the TALF
The markets paid little initial attention to another key element discussed by Geithner, the Consumer and Business Lending Initiative. Perhaps that’s because it wasn’t truly new but was built upon a Fed-designed Term Asset-Backed Securities Loan Facility (TALF) that had already been developed under emergency powers but had not yet been implemented.
On March 3, the Federal Reserve and the Treasury jointly announced the launch of the TALF. This effort recognizes that the Fed’s massive efforts to provide liquidity to banks and primary securities dealers have not been able to overcome the reluctance of financial intermediaries to extend and hold credit when concerns about capital, asset quality, and credit risk are dominant.
The TALF provides financing directly to private investors in credit markets that are considered key to economic recovery. The TALF seeks to revive lending that previously had been financed through major components of the private asset–backed securities (ABS) markets. The ABS markets were major credit channels as recently as 2007, but have been virtually shuttered since the worsening of the financial crisis last October.
The TALF initially will make up to $200 billion in loans to investors to support their purchase of targeted asset-backed securities. The ABS must be high quality and must be backed by recently originated loans. At the outset, TALF loans will have a maturity of three years. The plan states that the interest rates on TALF loans “will be set with a view to providing borrowers an incentive to purchase newly issued eligible ABS at a yield spread 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.”
The TALF initially will focus on the ABS markets for auto loans, credit card loans, student loans, and SBA-guaranteed small-business loans. Plans are underway to accommodate other asset types, possibly including commercial and private-label mortgage-backed securities.
Break with the Past
The TALF goes well beyond standard measures of monetary policy. This facility combines Federal Reserve liquidity with capital provided by the Treasury, and the facility effectively substitutes public (Federal Reserve) for private balance sheet capacity in a period of sharp deleveraging and risk aversion in the private sector.
The key virtue of the TALF program in the current context is that it allows the Fed to push down rates and ease credit conditions in a targeted range of markets, despite the fact that the federal funds rate is essentially at its lower bound and cannot be pushed lower.
The TALF is a bold and highly complicated experiment. The Fed and the Treasury expect the program to eventually stimulate up to $1 trillion in new credit creation as a range of ABS markets are revived. The TALF may prove to be key to financial stability and economic recovery by late this year at little or no cost to taxpayers.
