5 Fund Managers for PPIP

Additional details of the Public-Private Investment Programme. Still going through teething problems in the implementation. Apparently they are looking at 5 fund managers to handle this. Original article in the FT

US shakes up toxic asset rules

By Francesco Guerrera in New York

Published: April 7 2009 03:00 | Last updated: April 7 2009 03:00

Hedge funds and small fund companies could get government loans to buy troubled securities from banks after the US Treasury changed the rules of its $1,000bn toxic assets plan on fears it would only benefit a few large investors.

The move, announced yesterday, came after lobbying by hedge funds and small investors who argued the large funds that helped shape the programme, such as BlackRock and Pimco, would be its main beneficiaries.

The Treasury's decision to amend the plan a fortnight after its creation underlines the difficulties in balancing investors' demand for speedy measures against the need to avoid rushed moves that cause more problems.

The original "public-private investment programme" (PPIP) stated that only funds with at least $10bn of mortgage-backed assets under management could become one of the five managers in charge of buying troubled securities from banks.

But in guidance, the Treasury said it was considering "opening the programme to smaller fund managers [with less than $10bn of eligible assets under management]", after it had selected the first batch of fund managers.

Hedge fund managers said the changes could enable smaller groups to take advantage of the cheap leverage being offered by the Treasury to entice investors to buy troubled securities from banks. "Treasury seems to have realised the original plan would have benefited a handful of 'mega-funds'," said one.

The authorities said they could appoint more than five fund managers in the first round and extended the application period from April 10 to April 24.

Selected fund managers will have three months to raise $500m from investors - a condition to receive government loans. The Treasury relaxed eligibility rules for the first set of fund managers.

The authorities said failure to meet one of the five original criteria, such as having headquarters in the US and having a record of managing bad assets, did not automatically disqualify an applicant. That could pave the way for foreign fund managers.

The Treasury stood firm on one of the plan's more controversial points - the ability of banks to participate as buyers of toxic assets. The loophole - reported in the Financial Times - sparked protests that banks would add to their stockpile of bad assets with cheap taxpayers' funds.

The Treasury was seeking applications from a range of institutions and would consider their "overall financial health" before approving proposals.

Nationalisation of Banks

Another good piece here arguing for nationalisation by Matthew Richardson http://www.voxeu.org/index.php?q=node/3143

Treasury Secretary Timothy Geithner’s financial plan calls for stress tests at the large complex financial institutions (LCFIs). These tests are due to start this week. They will involve estimates on the eventual losses due to default on a wide variety of assets.

Economic analysts have already performed such a test at the aggregate level. The results were not pretty. For example, Goldman Sachs looked at the US banking sector’s holdings of the current “toxic” pool of assets, such as option ARM residential mortgages, subprime residential mortgages, Alt-A residential mortgages, credit card debt, second liens/home equity loans, consumer auto loans, and commercial real estate. Expected losses come in at around $900 billion. These losses give the banking sector very little wiggle room. Therefore, there is the real possibility that some LCFIs are bankrupt – the face value of their liabilities exceeds the current value of their assets.

Insolvent financial institutions

If a bank is insolvent, there are three general ways to attack the problem.

The first is unbridled free-market capitalism. I am sympathetic to this view. I wish we somehow could figure out a way to let the market work and let these institutions fend for themselves. Shareholders, creditors and counterparties knew the risks they were getting into. After all, why is some debt secured, why do we have collateralised lending, why do riskier assets deserve larger haircuts, etc? But when Lehman Brothers went down, we looked into the abyss. This would be the equivalent of nuclear armageddon for the financial system.

The second option is to provide government aid to the insolvent bank – to in effect throw good money after bad. This is sanctioning private profit-taking with socialised risk. Since October of this past year, the government has followed this strategy. Let the banks plod along, throwing money here and there to keep them afloat, at usually way below-market prices at a high cost to taxpayers.

It is not a totally crazy solution. There may well be a positive externality to spending taxpayer money to save a few so we can save the entire system. For economists specialising in the field of banking, however, this approach has a familiar ring to it. In Japan’s lost decade of the 1990s, its banks kept loaning funds to bankrupt firms so as not to writedown their own losses, which resulted in the government supporting zombie banks supporting zombie firms.

As an example, consider the poster child for the “freebie” programmes, the Temporary Liquidity Guarantee Program, started in late November of 2008. For a cost of 0.75%, it allows banks to issue bonds backed by the government, essentially risk-free. The banks have accessed this market 97 times for $190 billion!

The biggest pig at the trough was Bank of America, which accessed it 11 times for $35.5 billion. Close behind were JP Morgan ($30 billion), GE Capital ($27 billion), Citigroup ($24 billion), Morgan Stanley ($19 billion), Goldman Sachs ($19 billion) and Wells Fargo ($6 billion). A not so surprising correlation with their respective writedowns (including merged entities): Bank of America $96 billion, JP Morgan $75 billion, Citigroup $88 billion, Morgan Stanley $22 billion, Goldman Sachs $7, billion and Wells Fargo $115 billion.

In terms of helping us exit the financial crisis, this programme has many problems. It charges each institution the same amount, so it hardly separates the solvent from the insolvent institutions. It charges a fee that is grossly below what these institutions could issue in the marketplace given their current balance sheets, distorting the system. Wasn’t that the Fannie Mae and Freddie Mac problem? And it is unlikely to cleanse the system of toxic assets, because it allows banks to continue business while out of money and hope that toxic asset prices increase. In effect, the access to this capital allows them to continue to make their original bets.

The final way of addressing insolvency is nationalisation. Over the past week, there has been debate about whether nationalisation is the right word. According to a standard dictionary definition, nationalisation is the act of transferring ownership from the private sector to the public sector. Although this is literally what we are discussing for certain banks, almost everyone agrees that the type of nationalisation that would take place would be a temporary one. Thus, if everything went as planned, a better analogy would be of the government acting as a trustee in a receivership of the bank.

That said, I do think a term like nationalisation is the appropriate description. It is a misnomer to think, as a number of pundits have suggested, that we have experience at nationalising banks through the FDIC. For example, the latest bank (and 39th of the current crisis) to be closed by regulators is the Silver Falls Bank of Silverton, Oregon. It has three branches and assets of approximately $131 million.

Silver Falls Bank is no Citigroup or Bank of America. The complexity, size and systemic nature of these institutions deserve deep analysis.

The basic argument for nationalisation is that we need an organisation to simultaneously facilitate the reorganisation of the large complex financial institutions and be a trustworthy counterparty to all current and ongoing transactions. The only one with the balance sheet right now is Uncle Sam. But make no mistake about it. With nationalisation of a LCFI, the government is the owner and the ultimate residual claimant. Once we take down the LCFI, we have crossed the Rubicon. The die is cast and there is no turning back.
It is therefore important to do it right. Nationalisation has its pros and cons.

The good bank, bad bank model

In order to have a healthy economy, we need a healthy financial system, and a healthy financial system requires that we cleanse the system of bad assets. Otherwise, creditworthy firms and institutions will not have access to needed capital, prolonging the economic downturn.

Such cleansing would be the primary benefit of nationalising some financial institutions. In receivership, it is much easier to separate a bank’s good assets and bad assets – to divest the firm from its toxic assets and troubled loans. This is because insolvent institutions will never take this action. If they did, it would by construction force them under.

How would it work? The healthy assets and most of the bank’s operations would go to the good bank, as would the deposits. Some of these deposits are insured; others (e.g., businesses and foreign holdings) are not. But the good bank would likely be so well capitalised that there would be no threat of a bank run. The net equity, i.e., assets minus deposits, would be a claim held by the other existing creditors of the bank, namely shareholders, preferred shareholders, short-term debtholders, and long-term debtholders.
The goal would be to reprivatise the good bank as soon as possible. After all, the point of the exercise is to create healthy financial institutions that can start lending again to creditworthy institutions. In almost every successful resolution of financial crises in other countries, this was the path.

Of course, the tricky part of nationalisation is the handling of the bad assets. The bad assets would be broken into two types – those that need to be managed, such as defaulted loans in which the bank would own the underlying asset, and those that could be held, such as the AAA- and subordinated tranches of asset-backed securities. With respect to the former, the government could hire outside distressed investors or create partnerships with outside investors as was done with the Resolution Trust Corporation in the 1980s savings and loan crisis.

Along with the equity of the good bank, these assets would be owned by the existing creditors. The proceeds over time would accrue to the various creditors according to the priority of the claims. Most likely, the existing equity and preferred shares would be wiped out, and the debt would effectively have been swapped into equity in the new structure. Under this scenario, it is quite possible, even likely, that taxpayers would end up paying nothing. This is because, for the large complex financial institutions, these creditors cover well over half the liabilities.

Does such a solution risk systemic bank runs?

The problem with the above solution is that it shifts all the risk of the insolvent institution onto the creditors of the LCFI. While this is fair to the extent the creditors were accruing the profits in normal times, it may lead to the “Lehman Brothers problem” – it risks runs throughout the system.

Why did Lehman Brothers cause systemic risk?

Was it the counterparty risk, e.g., fear of being on the other side of interest rate swap, credit default swap, or repo transactions? This fear was well founded. Ask any hedge fund whose hypothecated securities disappeared in Lehman’s UK prime brokerage operations. It is pretty clear that the government would have to stand behind any counterparty transaction and publicly commit to this rule. Since most of these are margined and collateralised, however, many of the assets would show up in the good bank.

Or was it the short-term debt? The run on money market funds was directly attributable to the Reserve Primary Fund’s holdings of a large amount of short-term Lehman commercial paper. One would presume the same thing would happen here as the short-term debt of all questionable LCFIs would come under pressure. It is highly likely that the government might have to step in.

Compared to the standard large complex financial institution, Lehman had very little long-term debt. To understand whether a collapse in the institution’s long-term debt value is systemic, one would have to analyse the concentration of this debt throughout the system. If it is widely held, it is unlikely to have systemic consequences. Of course, it would have profound effects on future financing of these firms.

If the government has to cover the creditors, or at least some of them, what has been gained?

On the positive side, the system will have cleansed itself of the assets.

Moreover, to minimise the cost to taxpayers, it is not clear that the government will have to step in. If the government is completely transparent to the market who is solvent and who isn’t, and the reasons why this is, then the type of uncertainty that surrounded Lehman’s failure may be mitigated. The runs on the equity and debt of banks in September and October 2008 may have occurred because there was no clear message from the regulator.

That said, actions speak louder than words, and, in a dynamic setting where conditions change rapidly, solvent firms can become insolvent very quickly. While the government needs to do a thorough stress analysis, consistent across all the major banks, to find out the trouble spots, the only definitive way it can prevent a bank run on solvent institutions is to backstop all the creditors of these institutions. Maybe the government can provide a haircut, guaranteeing X% of the debt. In any event, in this case, the creditors of the insolvent institutions would not have to be protected.

Advantage: Nationalisation solves the toxic asset problem

It has been argued that trying to implement nationalisation will be near impossible because we won’t be able to price the hard-to-value “toxic” assets. It is actually the opposite. The current problem is that banks don‘t want to sell the assets at the price the market is willing to pay for them. If we were banks, we wouldn’t want to sell them either. As long as the government is providing free money, why not continue to hold out? Hope is eternal.

But let’s be real. The banks bought illiquid assets with credit risk using borrowed short-term liquid funds. For taking these types of risk, the banks earned a hefty spread. And, in normal times, they raked it in. But there is no free lunch in capital markets. In rare bad times, illiquid, defaultable assets are going to be greatly impaired. There is no mulligan here. It will be easier to resolve this within a receivership.

To make the point using a real economy analogy, this past Christmas, Saks Fifth Avenue sold their designer lines at a 70% discount. Designer labels and boutique shops on Madison Avenue were up in arms. How could they sell $500 Manolo Blahnik shoes for $150? In this economy, they are $150 shoes.
Moreover, receivership allows one to separate out the assets without having to price them.

Disadvantage: How to manage a nationalised bank?

Does the government have the ability to run a large complex financial institution? In a recent conversation, Myron Scholes told me he was also in favour of nationalisation – as long as it lasts just 10 minutes.

These institutions have literally tens of thousands of transactions on their books –, who is going to manage a LCFI while it is a government institution, good bank or bad bank? Certainly, no one envisions Barney Frank or Christopher Dodd as the Chief Investment Officers of these firms, but there are many concerns. The government can go and hire professionals as they have done with Fannie Mae, Freddie Mac, and AIG. But much of the value of a Wall Street firm is in its vast array of intangible, human capital. This labour is incentive-driven. How much franchise value will be lost during the nationalisation process?

Let’s assume this gets sorted out and the government mirrors employment practices at other firms. But then, with the government’s protection in receivership, what is to prevent the LCFI from making too many, risky loans? They will have a competitive advantage over solvent, albeit less-supported banks. This issue has recently come up with other government-supported institutions. Indeed, the argument has been made that AIG and Northern Rock, to name just two institutions, have undercut their competition by offering overly cheap insurance and mortgages, respectively.

Advantage: Nationalisation addresses the moral hazard problem

There is something unseemly about managed funds buying up the debt of financial institutions under the assumption that these firms are “too big to fail”. In theory, these funds should be the ones imposing market discipline on the behaviour of financial firms, not pushing them to becoming bigger and more unwieldy.

It has been said by many that this is not the time for thinking about moral hazard. I disagree. If we bailout the creditors, then effectively we have guaranteed the debt of all future financial institutions. We have implicitly socialised our private financial system.

It is certainly true that we can institute future regulatory reform to try to quell the behaviour of large complex financial institutions. But this will be complex and difficult to implement against the implicit guarantee of “too big to fail”.

Thus, nationalisation resolves the biggest regulatory issue down the road, namely the “too big to fail” problem of banks that are systemically important. In one fell swoop, because the senior unsecured debtholders of a bank will lose when it is nationalised, market discipline comes back to the whole financial sector.

So the large solvent banks will have to change their behaviour as well, leading, most likely, to their own privately and more efficiently run spin-offs and deconsolidation. The reform of systemic risk in the financial system may be easier than we think.

Concluding remark

We are definitely caught between a rock and a hard place. But the question is – what can we do if a major bank is insolvent? Sometimes the best way to repair a severely dilapidated house is to knock it down and rebuild it. Ironically, the best hope of maintaining a private banking system may be to nationalise some of its banks. Yes, it is risky. It could go wrong. But it is the surest path to avoid a “lost decade” like Japan.

Epilogue: Sweden¹

Sweden has been cited frequently as a model of “nationalisation”. While this is probably an exaggeration, the Swedish approach is in many ways a model in terms of the principles it puts forth to handle a financial crisis. Putting aside the obvious fact that Sweden’s economy is much smaller and its financial institutions much less complex, it is a useful exercise to describe some basic facts.

The distribution of assets within the Swedish and US banking system were similar. For example, while Sweden had 500 or so banks, 90% of the assets were concentrated in just six. In the US, while there are over 7,500 institutions, and the majority of assets are concentrated in the top 15 or so.

Sweden’s credit and real estate boom in the late 1980s closely mirrors the recent US boom prior to the crisis. There was even a similar shadow banking system that developed during these periods – in Sweden, unregulated companies financed their operations via commercial paper; in the US, unregulated special purpose vehicles used asset-backed commercial paper. When the bubbles began to burst, there were also sudden collapses in these markets as a few of these companies and special purpose vehicles began to fail.² Ultimately, the funding came back to the banks, causing them to have large exposure to the real estate market.

As conditions eroded in 1991, the Swedish government forced banks to writedown their losses and required them to raise more capital or to be restructured by the government. Of the six largest banks, three – Forsta Sparbanken, Nordbanken and Gota Bank – failed the test. One received funding and the other two, Nordbanken and Gota bank, ended up being nationalised.

These latter two banks had their assets separated into good banks and bad banks. The good banks ended up merging a year later and were sold off to the private sector. The poorly performing loans were placed in the bad banks, respectively named Securum and Retrieva. These banks were managed by asset management companies who were hired to divest the assets of these banks in an orderly manner. (It took around four years.)

The main lessons from Sweden for the current crisis are:

1. Decisive action in terms of evaluating the solvency of the financial institutions.
2. Some form of “nationalisation” of the insolvent firms.
3. Separation of these insolvent firms into good and bad ones with the idea of reprivatising them.
4. The management of the process was delegated to professionals, as opposed to government regulators.

While complexity may affect the application of these principles to the current crisis, it does not nullify them.

---

1 Many of the facts here are taken from Tanju Yorulmazer’s “Lessons from the Resolution of the Swedish Financial Crisis.”
2 In Sweden, in September 1990, a finance company called Nyckeln went bankrupt, while in the current crisis, in early August 2007, three ABCP funds run by BNP Paribas halted redemptions, leading to a run on the system.

Geithner's Public-Private Investment Programme

From BT today

"Under the public-private investment programme announced by US Treasury Secretary Timothy Geithner on Monday, the government will pump money into joint-venture investment funds with private investors to buy up to US$500 billion worth of soured mortgage debt and other troubled assets from banks. The special-purpose funds will be privately managed, but subject to close watch by US regulators.

The government is offering to provide half the seed capital for these investment vehicles, drawing US$100 billion from its war chest under the Troubled Assets Relief Program. It expects private-sector investors such as Pimco, BlackRock and hedge funds to provide the other half of the equity capital.

The government will then offer loans to the special-purpose funds or guarantee debt securities that they issue, to finance their purchase of the toxic assets. Through this leverage, the government estimates the programme could be expanded to buy US$1 trillion worth of hard-to-value assets from banks.

Banks holding such assets, which include billions of dollars of debt securities backed by pools of mortgages and other loans, are reluctant to dump them at the distressed prices that private investors would pay without government support, forcing massive writedowns. Meanwhile, fears that the value of the underlying collateral will collapse further as the US economy worsens have put off potential buyers. Equity investors, worried that the banks will ultimately shoulder the losses, have driven the share prices of many banks to record lows.

By sharing the risk of losses through its co-investment, the government hopes that it will be able to attract private capital, especially from pension funds, insurance companies and other long-term investors back into the market.

'It could be just what we need' to start the world's biggest economy on the slow road to recovery, said David Cohen, director of Asian economic forecasting at Action Economics in Singapore. 'After all, what has been the major hurdle to allow the economic recovery to get started was the fear that the banking system was still frozen and would not be able to finance the recovery with the necessary credit flows.'

But the plan also came under fire from other economists, including Nobel laureate Paul Krugman, who argued that the government support is effectively a subsidy to encourage private investors to buy banks' unwanted assets for more than they are worth, using money from the public purse.

The latest proposal, wrote Mr Krugman in The New York Times, 'would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt'.

Here is Krugman's Op-Ed Piece criticising the Public-Private Investment Programme. Clear here that Krugman's recommends nationalisation of the banks.

Over the weekend The Times and other newspapers reported leaked details about the Obama administration’s bank rescue plan, which is to be officially released this week. If the reports are correct, Tim Geithner, the Treasury secretary, has persuaded President Obama to recycle Bush administration policy — specifically, the “cash for trash” plan proposed, then abandoned, six months ago by then-Treasury Secretary Henry Paulson.

This is more than disappointing. In fact, it fills me with a sense of despair.

After all, we’ve just been through the firestorm over the A.I.G. bonuses, during which administration officials claimed that they knew nothing, couldn’t do anything, and anyway it was someone else’s fault. Meanwhile, the administration has failed to quell the public’s doubts about what banks are doing with taxpayer money.

And now Mr. Obama has apparently settled on a financial plan that, in essence, assumes that banks are fundamentally sound and that bankers know what they’re doing.

It’s as if the president were determined to confirm the growing perception that he and his economic team are out of touch, that their economic vision is clouded by excessively close ties to Wall Street. And by the time Mr. Obama realizes that he needs to change course, his political capital may be gone.

Let’s talk for a moment about the economics of the situation.

Right now, our economy is being dragged down by our dysfunctional financial system, which has been crippled by huge losses on mortgage-backed securities and other assets.

As economic historians can tell you, this is an old story, not that different from dozens of similar crises over the centuries. And there’s a time-honored procedure for dealing with the aftermath of widespread financial failure. It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books.

That’s what Sweden did in the early 1990s. It’s also what we ourselves did after the savings and loan debacle of the Reagan years. And there’s no reason we can’t do the same thing now.

But the Obama administration, like the Bush administration, apparently wants an easier way out. The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn’t be in trouble.

And so the plan is to use taxpayer funds to drive the prices of bad assets up to “fair” levels. Mr. Paulson proposed having the government buy the assets directly. Mr. Geithner instead proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the stuff. The idea, says Mr. Obama’s top economic adviser, is to use “the expertise of the market” to set the value of toxic assets.

But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.

The likely cost to taxpayers aside, there’s something strange going on here. By my count, this is the third time Obama administration officials have floated a scheme that is essentially a rehash of the Paulson plan, each time adding a new set of bells and whistles and claiming that they’re doing something completely different. This is starting to look obsessive.

But the real problem with this plan is that it won’t work. Yes, troubled assets may be somewhat undervalued. But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus — for that is what the Geithner plan amounts to — will change that fact.

You might say, why not try the plan and see what happens? One answer is that time is wasting: every month that we fail to come to grips with the economic crisis another 600,000 jobs are lost.

Even more important, however, is the way Mr. Obama is squandering his credibility. If this plan fails — as it almost surely will — it’s unlikely that he’ll be able to persuade Congress to come up with more funds to do what he should have done in the first place.

All is not lost: the public wants Mr. Obama to succeed, which means that he can still rescue his bank rescue plan. But time is running out.

Another idea by one in one of the comments, John G...

"First, admit that the zombies are in fact dead and that they aren't coming back.

Second, come up with legislation to allow for their orderly termination through a government run receivership (not a bankruptcy) following the FDIC model for insolvent banks, extended to the holding companies.

Third, sell the assets off to existing banks and/or create new, smaller, banks to buy the assets. Distribute the customers (depositors) to these instiutions.

Finally, there will be some assets so toxic that nobody would take them, and there will be some liabilities that nobody will assume at a reasonable price. The government will have to retain these and deal with them over time.

The whole package could be financed by an issuance of 30 year bonds at what are historically low interest rates.

Who loses - the current bank management (who will lose their salaries, bonus payments, perks, and golden parachutes), the bond holders of the institutions (who will have to take a haircut, if not getting scalped), and the Wall Street crowd who saw a risk free opportunity to profit. Who profits - the American people."

US Attempt to Support Small Business Loans

Okay, this is really tricky... and it took me sometime to digest this press release to better understand how the US govt is trying to help loans to the Small Businesses. However, let me give this a shot. What I found most useful was this white paper from the US treasury.

Importance of Securitization Markets
This is important to understand why US doesn't go through the banks (i.e. offer risk sharing on defaults of loans given out by banks like the UK) to address the credit crunch to small businesses. Over the past two decades in the US, what banks have used to raise funds for loans to small businesses is to create Asset-Backed Securities (ABS) through collateralising these loans and then selling them to investors.

To do this, a bank sells their pool of loans (or the loans they intend to give out) to a Special Purpose Vehicle (some other created legal entity). The SPV then splices them up based on different risk levels and then sells it to different investors.

The reason why this has been so popular, that it broadens the investor base and as a result brings funds in more easily and cheaply. This is as compared to our system where, banks fund such borrowings either from deposits from their consumers, or through raising money from the capital market.

Credit Crunch has dislocated ABS market
Federal Reserve data shows that around 1/4 of all non-mortgage consumer credit (here could include car loans, college tuition as well as small busines loans) have been funded out of ABSes. As a result of the severe dislocation of these markets, new issuance has come to a virtual halt in Oct 2008.

TALF Plan of Attack
TALF's plan of attack is to lend money to potential investors of these ABS so as to catalyze the flow of funds into the banks to allow them to lend. The Federal Reserve Bank of New York will lend up to $200bn to holders of eligible ABS. Investors will be charged an interest rate which includes risk premium for these loans and will have to put up the respective collateral (the asset behind the securities themselves) for such government funding. Depending on the risk of the loans, investors may have to put up higher level of collateral then the loan given out ("haircuts") For instance, if the haircut is 10%, then to receive a $90 loan, investor must give $100 in collateral. $20bn has been set aside for possible defaults (10% rate assumed)


http://blogs.wsj.com/privateequity/2009/03/04/pes-glass-is-talf-full/
PE’s Glass Is TALF Full

By Shasha Dai

Now that the details of the government’s TALF plan have been unveiled, private equity firms find themselves intrigued.

TALF - short for Term Asset-Backed Securities Loan Facility – will provide three-year loans at relatively low interest rates to private investors, who will in turn buy securities backed by newly- or recently-issued consumer debt like car loans, student loans and credit card receivables. The program aims to re-open the securitization market so that banks will start lending to consumers again.

Several private equity firms have already expressed interest in participating. Blackstone Group Chairman Stephen Schwarzman told papers including The Wall Street Journal that his firm is considering investing in securities using TALF funding. The Journal also reports that hedge funds Millennium Capital Management, Cerberus Capital Management and Fortress Investment Group are considering participating.

Other firms with expertise investing in debt include Oaktree Capital Management LLC, Apollo Management LP, Ares Management LLC and Bain Capital. Officials at those firms either declined comment or said they haven’t made a decision yet.

Those firms that do go after this program may face some pushback from their LPs. Investing in consumer loan-backed securities is new to most PE firms – Blackstone, for instance, hasn’t been involved in this area in the past. A similar issue recently arose for some firms, including New Mountain Capital and BC Partners, when they decided to move into debt investing and had to seek LP approval.

“The first issue is what they tell their LPs,” said Steven Kaplan, a professor at University of Chicago Graduate School of Business. “For some, this is off-strategy, and some LPs will not like it.”

But whether or not buyout firms decide to tangle directly with TALF, they should still benefit tangentially from the program. TALF’s intended unlocking of consumer credit should help portfolio companies in related industries, such as auto finance companies or for-profit colleges, by increasing demand for their services.

However, TALF probably won’t have much direct impact on the lending markets buyout firms most want unlocked - those for their own portfolio companies - since it doesn’t address things like high-yield bonds. TALF only finances purchases of AAA-rated securities, or those backed by the most secure debt.

“It won’t help PE firms (directly), as financing for PE transactions comes from high-yield bonds and institutional loans,” said a senior loan officer at a large bank who asked not be named.

But it’s a beginning.

“This is a little bit of experimentation,” said Mitchell Hollin, a partner at growth equity investor LLR Partners. “The securitization market is a long way from coming back.”

Will look at the following website detailing US govt's credit assistance plans in a following post. http://www.financialstability.gov/