The worst fears about the Federal Reserve’s program to revive consumer and small business lending did not come to pass. There had been concern that technical complications and political backlash about bonuses for companies taking government assistance might have investors shying away from participating in the Fed’s Term Asset-backed Loan Facility.
But yesterday the Fed’s New York office said it would lend investors $4.7 billion next week in the programs first instalment . That’s a modest begining, and falls short of what many of the more optimistic analysts and Fed officials expected. But it wasn’t the wash out that some fear.
Under the terms of the program (which we’re illustrating the a picture composed of Mr. T and Alf), the Fed and the Treasury will provide steeply discounted loans to investors to purchase asset backed securities. Those securities will be bundles of auto-loans, student loans, credit card debt, small business loans and possibly other types as well. The government will also provide a guarantee against big losses to the investors.
It’s hoped that hedge funds and private equity firms will buy securities now that they have both cheap financing and a limited downside from the government. Eventually, the Fed plans to lend up to $1 trillion under the program, which will have monthly disbursements.
One concern from some potential investors has been the chance that a security will be deemed ineligible for the program after it has been purchased, stripping the investor of the guarantee and bringing on higher interest costs.
Another concern has been the role of banks in the program. Under the program, the banks will bundle the loans into securities. This will bring in fees when the securities are sold to investors. Some investors see this as a giveaway to banks. Others worry that the banks, who have some responsibility for evaluating the fitness of potential investors and securities under the program, will be too intrusive or play favourites when selecting investors.
Some of the public may be surprised that the goverment is actively promoting securitization. The practice of permitting banks and others to make loans that are then bundled and sold to other investors has been criticised as one of the causes of the economic problems. It divides those making the loans from those who bear the ultimate risks of default and creates opacity about the quality of the loans. In some ways, the government’s cheap loans and guarantees could make this problem even worse.
The government seems to have concluded that the dangers of reckless lending and securitization are outweighed by the economic costs of investor fear and tightened lending rules that have all but dried up the securitization market.