Troubles With TALF

Can’t they figure this stuff out? The WSJ Real Times Economics blog points out that TALF may do much less than advertised for the auto industry.

The key is that TALF is set up only to buy triple-A rated securities. The problem is creating those securities.

You may recall that somewhat late in the came automobile dealer flooring loans were included as eligible collateral. These are the loans that the dealerships take out to finance their inventory. Unfortunately, no security made up of floor plan loans is rated AAA. Moody’s even goes so far as to say that the risks associated with this type of lending are incompatible with a triple-A rating.

In other words no way, no how.

Well, you say, at least the buyers will get some relief. Maybe not. Here’s how the blog describes the problem. 

The Fed’s triple-A requirement for TALF collateral could also steer its benefits to auto buyers with strong credit.

To make securities backed by auto loans triple-A rated, issuers cushion them by assigning the initial losses (from borrowers who don’t repay the loans) to separate, lower-rated securities.

Before the credit crisis, many of these lower-rated pieces would be sold off to investors. But rising delinquencies and a gloomy economic outlook have since scared off buyers. This means that companies that package these securities have to bring the lower-rated portion on their balance sheets — an unattractive prospect for lenders.

For borrowers, “the underwriting will continue to be much stricter because the loans will be on the lenders’ balance sheets,” says Steven Pittler, president of Friendly Finance Corp., a small loan lender to auto dealers. “Now it’s the company’s money that’s on the line.”

This will shut out a large population of potential car buyers. In November, GM said nearly three-fourths of customers had a credit score below 700. The median credit score for U.S. consumers is about 723.

If you step back and think about this, the net result of any increase in lending for auto company loans might well be to concentrate more risk on lenders’ balance sheets. Since they can’t off load this debt to investors and as the Fed is skimming the best part is the unintended consequence of trying to goose credit the introduction of more risk into the private sector.

Actually, at first thought, I can’t see any reason why the analogy wouldn’t apply to most of the assets that are eligible for TALF financing. The entire construct relies on the securitization model and that model relies on tranches of risk. Absent a viable market for the lower rated tranches what are we really achieving.

The Fed has a lot of people much smarter than me, so what am I missing here?

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