Term Asset Backed Securities Loan Facility

The Federal Reserve Board has come up with another program to plan to restore stability to our financial system by jump starting the credit markets and the economy.

The program was actually first announced back in November 2008 with $200 million of funding and was expanded recently with $1 trillion in funding.

The Term Asset Backed Securities Loan Facility (TALF) program is designed to make it easier for banks to sell loans they have made to investors. The market for these loans stopped functioning. As a result banks had to hold onto these loans, further deteriorating their financial stability and severely crimping new lending by banks.

Through the TALF program, the government will lend investors up to 95 percent of the face value of these securities. The terms the government is offering to potential investors is so generous they can expect returns of up to 15 to 20 percent! Not a bad return, especially when rates earned on deposits are so low.

In this example the returns are much higher than 15 to 20 percent. Imagine if a hedge fund bought $10 million in these distressed securities for 20 cents on the dollar, only having to put in $500,000. The government chips in $9.5 million. Now these securities will never return to par (100 cents) but let’s assume when the economy recovers they are able to sell these securities for 40 cents on the dollar. Their return would be 100 percent on the value of the securities. They repay the government the original $9.5 million plus interest, say $1 million in interest, they would have earned $9 million dollars on their original cash investment of $500,000.

Considering that the government is providing the funding, this kind of return on an investment will make of plenty people angry. Isn’t this the kind of financial trickery that got us into trouble? Maybe so, but at this point the government is so desperate to restore stability to the financial markets it’s willing to risk the wrath of the American public.