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Gimme Credit

Posted by Larry Doyle on March 20, 2009 8:56 AM |

In the midst of all the wrangling in Washington, Wall Street, and literally all around the world, the biggest concern for everyday Americans is the accessibility of credit. I am sure everybody reading this post has either had issues gaining credit or knows of people who have had issues gaining credit. The knee jerk reaction for this lack of credit is to lash out at those big, bad banks. Well, those big, bad banks along with their smaller counterparts only provide approximately 50% of the consumer credit in our economy.

Where did the other 50% of credit emanate and where did it go? Welcome to the world of asset-based financing and in turn Asset-Backed Securities. I highlighted back on November 12th that the Wall Street Model is Broken…and Won’t Soon Be Fixed. Well, the breakdown and discontinuation of the ABS market is truly the equivalent of the total collapse of one of your lungs. Try to go about your daily business and all of your activities with access to only half the oxygen supply as normal. Might get a little winded? Might struggle to perform? Might tire rather quickly? Might be less efficient and productive? Well, folks, given the shutdown of the ABS market that is exactly what our economy has been experiencing.

Why did the ABS market shut down? In so many words, the blood that was flowing through the arteries was polluted with toxins. What does that mean? The blood, that being the loans underwritten by banks and lenders which would be securitized by Wall Street, lacked the necessary underwriting discipline. In turn, investors totally walked away from the market. As a result, the vitality generated by the return of the blood to the heart did not occur. What does that mean? Once loans are sold through the securitization process, the capital proceeds (blood) generated by the sale are used to make new loans.

How do we restart the engines of this model so credit can flow once again? How do we incentivize investors to reenter the market? Welcome to the TALF (Term Asset Backed Lending Facility). Through this facility, the government will provide significant capital to investors and share significant risk with investors to purchase securities backed by consumer loans. Bloomberg reports Fed Gets $4.7 Billion in Loan Requests for Debut of TALF Plan.

While initial details in launching this plan took a while to untangle, enthusiasm by investors is growing. That is a good thing. Will we get the full use of our other lung back soon so we can get back to business as usual? Well, don’t hold your breath, no pun intended. The Bloomberg piece indicates that investors are receiving a rate of approximately 3.5% above Libor (London interbank overnight rate) to purchase some of these securities. For what it is worth, when the blood (loans) was clean and flowed smoothly, investors used to receive a return of approximately .35% above Libor. What does this mean? If the TALF is successful in restarting the ABS market, increased credit may begin to flow slowly through to consumers again, BUT do not expect the price of that money to come down anytime soon.


  • Mountainaires

    Doesn’t sound like such a great deal to me, although I’m certain that in certain quarters they’re rubbing their greedy paws together in glee…

  • Larry Doyle

    Great link. Thanks for sharing.

    No doubt that there is risk involved in this program for the public.

    “With a government guarantee, private investors could buy securities at an agreed-on discount with the additional comfort that if the performance of the security further deteriorates, the government guarantee would cover some or all of the unexpected loss,”

    That statement right there highlights that this TALF is very much a buyers’ market.

    Regrettably the alternative is an ongoing complete and total shutdown of this market until we have a period of prudently underwritten loans to securitize. That process may take a while.

    In short, this TALF may bring money/credit back into the economy but it is going to be expensive. More unintended consequences.

  • lizzy

    Do you think that the demand for credit has dropped? The way the economy is I would be reluctant to get anything that I would have to repay money. It was a little mind boggling to me that the article was talking of people borrowing money to buy the securitized credit assets.

  • Larry Doyle

    There is no doubt that overall demand for credit has dropped but it has not totally evaporated.

    The point you raise about borrowing money is focused on investors borrowing. From the investors standpoint, having the government lend them money to purchase these assets is actually a great deal.

    As Mountainaires highlights in the link provided in an earlier comment,the investors are getting a great deal while the public is taking a lot of the risk. Why would the govt do that? The govt needs to provide significnat incentive for investors to reenter this market in hopes of restarting the flow of credit from the ABS market.

    I hope that helps your understanding of this issue.

  • lizzy

    Privatize any profit and socialize the risk. I didn’t think of it in those terms; thanks for the explanation. I just read an article by Dani Rodrik about blaming economists not economics from your Syndicat reference. Interesting idea that economics study provides a toolbox but individual economists may focus to intently on certain aspects.

  • Larry Doyle

    I am glad you tapped into that Thought Leaders/Project Syndicate link. There are a LOT of very insightful peopel with a wide array of global perspectives in there.

    Back to the TALF. This program is most definitely a private profit/social loss mechanism. Tough medicine to swallow but in the midst of very little overall credit in the economy, there are not a lot of other alternatives.

  • thinkaboutthis

    My disclaimer: learning as I go and reading about all these financial situations — lol.

    Now, I am wondering exactly why anyone in their right mind would do anything involving a government backed dollar when yesterday (bonus taxing) was the epitome of how the government will, at its beckon call, do whatever it takes to crucify people in a mob style — the words of that democratic representative from Coloroda should become a video for all to listen to. ‘Pitchfork, hunt you down…’ etc.

    Granted there has been an enormous amount of smart people working within the confines of the law and capitalized because of it. However, with all of these bureaucratic types applying the epitome of emotion and game playing — how is any sensible businessman going to be able to assess a sturdy decision when you have so many with power vacillating at a moment’s notice?

    • Larry Doyle

      Think….great point. I got off the phone an hour ago with a close friend who raised the same point. How and why would any business person want to enter into a contractual obligation with the govt if legislation can be passed in a haphazard fashion to negate contracts.

      I do not mean to support AIG employees who did not deserve payouts but I do think your point is a very valid one.

      What is the ultiamte cost of all this? Rates to borrow money will have to go up because lenders are faced with ever greater risks. Higher risks can only be offset with higher returns which are commensurate with higher rates.

      Good point!!

      • thinkaboutthis

        and herein lies the problem Lar, remember a few days ago that I think USA business men are going to pull out of American markets and foreigners pull in.

        Again, I am no expert on markets by any stretch of the imagination, however, I sense a major underlying shift of American mores and psyche at play here.

        This drop and obliteration in the markets is more than a lack of confidence as to why it is not going to come back. The mentality of the generation that is involved does not think like the Warren Buffets types — they were raised differently and entered their work lives in a different generation. They will not stand for ‘loyalty’ of homegrown markets and go down the tubes. They are bigger and better at self preservation than people give them credit for and are more apt to resist regulations interfering with their lifestyles than the types of mentalities of even the 60s.

        Let me give an example. Years ago the term, ‘honor amongst thieves’ was a do or die creed. Now it is ‘every man for himself’. If the government of the USA does not start putting serious thought into the change of mentalities that each generation possesses within their strategies — then they are missing an important aspect of recovery. Why? Because of mass communication and mass technology and mass transportation.

        I keep saying to a friend every time I hear all these solutions. They are missing the global mentality of the American that is younger than the Warren Buffet types that have allot more influence globally than I believe they realize. These younger people will create markets abroad and move there.

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