Can the TALF Return Demand to the Markets?
We can now enter a new acronym into our lexicon: TALF. And what is TALF? The Federal Reserve and the Treasury announced on November 25th that a Term Asset-backed securities Loan Facility will be created to provide liquidity for purchasers of ABS’s (Asset-Backed Securities, which include mortgage-backed securities). Asset-backed securities also include student loans and car loans, which under normal conditions are packaged and sold to investors willing to take a risk that has been evaluated by another institution.
The trouble is, no one can be certain how thorough those institutions (specifically banks) were in their risk assessment process. Banks need to package and sell these securities in order to remove potential liabilities from their balance sheets, but when it becomes virtually impossible to slog through the tranches of loans within those securities, investors can easily become gun shy. To witness the headaches that these loans are causing banks, take a look at the chart below.
So as our trusted officials continue their efforts to restore confidence in the markets, and as the demand-led recession deepens, this task seems increasingly Herculean. Paulson & Company have resorted to some extremely desperate measures to pull this one off. To fund the TALF, approximately $600-800 billion will have to be committed, which nearly equals the amount of the original bailout plan. $20 billion of that money is, in fact, coming from the bailout plan. The other remaining billions are being leveraged, a fairly astonishing fact whose implications remain unclear. One thing is for certain: if the Fed wishes to avoid an inflationary spiral, destruction of money will become a necessity once this crisis begins to abate.
It would appear that the Fed’s announcement caused a positive reaction in the mortgage markets, however, Mortgage prime rates dropped from 6.3% to 5.5%, a relatively massive decline, and a huge wave of refinancing ensued…in a matter of hours, essentially. Could that be a forward indicator? Credit Suisse Group mortgage strategist Mahesh Swaminathan thinks so, saying that he expects to see rates drop below 5% in the near term. While there are some strict requirements for homeowners hoping to refinance, this is obviously a positive for the consumer. And while these measures do little to halt the rising tide of foreclosures, it does help the demand side of the issue. And in a demand-led recession, such as the one we are in, has the Fed finally stumbled upon the right combination to stimulate the markets?