Fed launches plan to revive consumer lending

The Federal Reserve and Treasury’s move Tuesday to pour billions of dollars into lending markets is an attempt to address the fundamental cause of the current economic crisis.

Though concerns about the financial system have centered recently on traditional banks, the financial breakdown began when the market for securitized loans collapsed. The subprime mortgage crisis revealed that the default risk for these loans – where loan money is bundled together then sold off in pieces – was higher than forecast. When investor funding evaporated, those who depended on those loans – from small businesses to car buyers – were left stranded.

The government hopes to stimulate as much as $1 trillion in new lending. The move comes as US stock markets sank this week to new 12-year lows on concerns that the global recession is deepening, and that these credit problems – central to the downturn – remain unresolved.

“It’s a way to jump-start securitized lending, which has been problematic,” says Brian Bethune, an economist at IHS Global Insight in Lexington, Mass. It won’t end the credit crisis by itself, but “it’s going to help.”

The Federal Reserve initially announced the program, called the Term Asset-Backed Securities Loan Facility (TALF), late last year as a $200 billion initiative. Since then, as the Fed has been working to get the program launched, the incoming Obama administration decided to make it a core element in its overall “financial stability plan.”

Even as that plan focuses on how to mend traditional banks, it also calls for Treasury funds to be used to help enlarge the scope of the Fed’s program, to spur as much as $1 trillion in new lending.
With all these efforts, speed is vital to success.

Dow drop

One sign of the pervasive worry about the economy: The Standard & Poor’s 500 stock index hovered around the 700 mark in afternoon trading Tuesday, a day after the Dow Jones Industrial Average sank to a 12-year low below 7000.

“The banking system continues to deteriorate as the economy deteriorates,” says Mr. Bethune. “It’s now going to take more policy action … to extract us from this recession than what they were saying even three months ago.”

So no policy at this point is a one-step fix for credit markets. But the Fed and Treasury see this one as very important.

The TALF aims to catalyze the frozen market for so-called asset-backed securities, investments in which the buyers earn a stream of income from a pool of underlying loans. The program will loan money to investors, who provide good collateral, to finance the investors’ purchase of high-quality (AAA-rated) credit securities.

“These markets have historically been a critical component of lending in our financial system, but they have been virtually shuttered since the worsening of the financial crisis in October,” the Fed and Treasury said in joint statement Tuesday.

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