Fed launches plan to revive consumer lending

Bernanke and Geithner affirmed Tuesday the importance of getting credit flowing, even if it involves taxpayer money.

Ben Margot/AP
The US is launching its plan to boost business and consumer loans for goods such as these overstocked Toyota Corollas and trucks on a lot in Hayward, Calif.

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.

The funds will begin flowing by the middle of this month, the statement said.

In separate hearings before Congress today, both Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner affirmed the importance of measures to get credit flowing, even if it means deploying some taxpayer money. The TALF would use Treasury funds as seed money to multiply the scale of the Fed program. Mr. Geithner also said more taxpayer money may be needed to strengthen weak banks so that they can keep lending.

Mr. Bernanke said that if federal deficits go up as a result, “I’m afraid they are unavoidable.”

The more that the market for securitized lending revives, the more loans traditional banks can make. That’s because they and other finance companies will be able to resell their loans in securities and not have to keep them in their own portfolios. Banks can only hold so many loans on their own books, especially at a time when they are struggling to maintain adequate underlying capital reserves as a proportion of loans.

The Fed-Treasury program starts with facilitating demand for the highest quality securities, but the hope is that that will have a gradual ripple effect on mid-quality lending as well.

“If there’s liquidity in the top-level market there’s the hope that there will be trickle-down, but there’s no guarantee,” says Rajeev Dhawan, director of the economic forecasting center at Georgia State University in Atlanta.

Few people expect that securitized lending will rebound to anything like the levels seen before the recession, due the breakdown in investor confidence that followed the collapse of subprime mortgage loans.

The economic downturn has also caused a wave of deleveraging, moreover, as tighter credit conditions force hedge funds and others in the financial industry to make fewer investments with borrowed money.

That in turn affects the supply of credit outside the financial sector, for households and businesses.

Still, finance experts generally say the concept of securitized credit is a sound one. What’s needed to revive it in a sustainable way is to rebuild trust in the system – such as through more reliable credit ratings and greater transparency and clarity in the investments themselves.

Stop-gap measure
In the meantime, the TALF is the Fed’s way of trying to keep credit flowing. In mortgages, the government sponsored entities Fannie Mae and Freddie Mac have been playing this role, by guaranteeing securitized home loans.

“Trying to jump-start that market [for securities] will jump-start the consumer market for borrowers who are credit worthy,” says Mr. Dhawan.

The result should be more loans for small businesses and college students, and maybe even some help for the auto industry, where sales volumes have plunged to historic lows as a percentage of US population.

Fed Chairman Ben Bernanke put the issue bluntly in recent testimony to Congress. He said economic recovery depends on fixing the financial system, not just on low interest rates or government stimulus.

“It’s not just the banks,” he said. “If we’re going to get the credit system going again, we need to address the nonbank credit sources.”

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