Thursday, February 12, 2009

Bailout of Securitization Market = Bailout of Banks

Eight top financial executives from various firms appeared yesterday before Congress. CNN reports:

Many of the CEOs at Wednesday's hearing defended their actions, noting that while credit standards have tightened, they were continuing to issue loans. Several of the CEOs added that without government assistance, credit would be even harder to obtain.

"We are still lending, and we are lending far more because of the TARP program," Bank of America Chairman and CEO Ken Lewis said in a copy of his prepared remarks.
Looking at the data, it looks like they may have a point (though they play a big part in this story later on). Since 1948, the commercial banking sector's share of consumer loan holdings dwindled from a peak of more than half the entire market (in the late 1970's), to less than 30% at the beginning of this decade.

The issue thus isn't only whether commercial banks are lending, but how to bring the securitization market back to life. Securitization holdings of consumer loans grew larger than that of commercial banks, all from nothing just 20 years ago.

And now the securitization market has all but ceased. WSJ's Marketbeat reports:
Securitization issuance is down 91% from this point last year, according to Dealogic, with asset-backed issuance declining to $2.6 billion from $32.1 billion at this point a year ago. Most consumer loans, such as credit cards, auto loans, student loans and others, are relatively easy to bundle and sell as securitized assets, but not now, when buyers of such product do not exist.
To summarize the problems in the securitization market (very high-level):

A) Nobody will buy securitized loans (which would restart the market) unless the yields are higher than that reported on bank balance sheets (although they do actually trade at these higher yields)
B) If these high yields were accepted as actual market prices (and not "forced selling" prices), it would force banks to write-down the value of their assets to the point where they could no longer pretend to be solvent

So.... solving problem A means banks are bankrupt (I am not opposed to nationalization, but "the forces" of corrupt politicians and their rich cronies sure are), while solving problem B means we are stuck in the present situation. Thus, without government intervention there appears to be no solution that solve BOTH A and B. This is where the TALF comes in. For details lets go to Morningstar:

Under the TALF, the Federal Reserve Bank of New York will lend to each borrower an amount equal to the value of the pledged ABS minus a haircut. The Fed posted a haircut schedule Friday.

Borrowers will be able to choose either a fixed or floating interest rate on TALF loans. The fixed interest rate will be 100 basis points over the three-year Libor swap rate, and the floating interest rate will be 100 basis points over one-month Libor.

In other words, the TALF will provide cheap, long-term financing, with no recourse to institutional investors, who can use this cheap financing to lever up the below market yields to an attractive level, all the while banks can continue to pretend they are solvent... what a beautiful plan. For everyone except taxpayers that is (who do you think is actually financing this leverage?)

Source: Federal Reserve


  1. alea had a part of the Axel Weber (head of Bundesbank) speech on securitisation.

    makes a lot of sense what he´s saying:

  2. Great post. This looks like a subsidy more than a loan. What's more, it could be years until the numbers come in.

    "I would like to stress that credit ratings should never replace the investor’s responsibility to evaluate the risk of a financial product."

    From the Fed:

    "Under the current specification of the TALF, the Federal Reserve Bank of New York will lend to eligible owners of certain AAA-rated asset-backed securities (ABS)"

    I could be wrong, but I'm assuming that Weber would agree with me, that we're relying on unreliable ratings, and that's also what GreenAB was getting at. Am I wrong?

    Don the libertarian Democrat

  3. Great graph.

    A couple of points. The only banks with lots of securitized assets are investment banks. This may include "combo" banks like BAC/MER and JPM. It definitely includes Citi. But Citi and BAC already have backstops on a lot of there exposure.

    About all WFC has is some auto stuff that doesn't seem to be a big deal. USB has almost none.

    Anyway, to restart securitization, we don't need to do anything with the old stuff. Let it amortize where it currently lies.

    We do need someone to buy the new asset backed securities. The only buyer now is the Treasury. So.....Isn't the answer to have ABS 2.0. Get rid of all the abuses, make em clean, transparent, and better.

    Since the Treasury is going to be the buyer -- in one way or another -- they should just order up the specs for what they want to own.

    I was just looking at Harley Davidson, and they used to securitize most of their motorcycle loans. They have been keeping them on balance sheet since they haven't been able to sell any since 1Q08.

    You can certainly do securitization without abuses. It was done pretty well for years.