Federal Reserve Continues to Push on a String

The AP noted today that With credit tight, Fed extends consumer loan plan:

With banks limiting the availability of auto, student and other consumer loans, the Federal Reserve said Monday it would extend a program intended to help spur more lending at low rates.

The program is set up to provide up to $1 trillion in low-cost financing to investors to buy securities backed by consumer and commercial loans. But private economists said the program, Term Asset-Backed Securities Loan Facility, or TALF, has so far provided little benefit for consumers and businesses still struggling to get credit.

The program, originally set to expire at the end of the year, has two parts.

The part aimed at boosting consumer and business lending is being extended through March. The part geared toward boosting new commercial real estate lending will run through June, because of the extra time typically needed to complete such deals. Delinquency rates on such loans have soared as companies have downsized or closed their doors, the Fed has said.

TALF was created in March, part of the efforts by the Fed and the Obama administration to ease credit, stabilize the financial system and fight the recession. Under the program, the Fed allows for low-rate financing for investors to buy securities backed by credit card debt, auto loans, student loans and loans to small businesses. The market for such loans essentially froze up last fall with the eruption of the worst financial crisis since the Great Depression.

The program has the potential to generate up to $1 trillion in lending, according to the government. But participation has been scant: As of Aug. 12, the value of loans outstanding stood at just $29.6 billion.

To get an idea of how successful the Fed’s program to bring back consumer lending has been, please consider the latest update on consumer credit:

total-consumer-credit-US-june-2009

In June 2009 total consumer credit volume dropped to $2.48 trillion. It fell by $17.2 billion (0.7%) from May 2009 and a total of $110.5 billion (4.3%) since its peak in December 2008; an ongoing corollary of deflation, overall contraction, and ending consumerism.

It is important to understand what is so misguided about these ideas. We hear it again and again, how the Fed will continue to push for more credit, borrowing, lending, consumption, etc. Rarely ever do we hear the question asked “Do people want any more debt?”. The simple answer: No. People are sick and tired of debt. The Fed can try as much as it wants, it won’t be able to force lending. When people have had enough they have had enough.

Since this causality is not intuitive for everyone to understand, Robert Prechter came up with a neat example that explains the concept a little better, I already posted it before:

Jaguar Inflation

I am tired of hearing people insist that the Fed can expand credit all it wants. Sometimes an analogy clarifies a subject so let’s try one.

[smartads]It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible. To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing it with tax money. To everyone’s delight , it offers these luxury cars for sale at 50 percent off the old price. People flock to the showrooms and buy. Later, sales slow down, so the government cuts the price in half again. More people rush in and buy. Sales again slow, so it lowers the price to $900 each. People return to the stores and buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn. Finally, the country is awash in Jaguars. Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory – ironically now made fact – the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving the economy will stop. So the government begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don’t care if they’re free. They can’t find a use for them. Production of Jaguars ceases. It takes years to work through the overhanging supply of Jaguars. Tax collections collapse, the factories close, and unemployment soars. The economy is wrecked. People can’t afford to buy gasoline , so many of the Jaguars rust away to worthlessness. The number of Jaguars – at best – returns to the level it was before the program began.

The same thing can happen with credit.
It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible. To facilitate that goal, it begins operating credit production plants all over the country, called Federal Reserve Banks. To everyone’s delight , the banks offer the credit for sale at below market rates. People flock to the banks and buy. Later, sales slow down, so the banks cut the price again. More people rush in and buy. Sales again slow, so it lowers the price to 1 percent. People return to the banks and buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats and an extra Jaguar to park out  on the lawn. Finally, the country is awash in credit. Alas, sales slow again, and the banks panic. They must move more credit, or, according to its theory – ironically now made fact – the economy will recede. People are working three days a week just to pay the interest on their debt so the banks can keep offering more credit. If credit stops moving the economy will stop. So they start giving credit away at zero percent interest. A few more loans move through the tellers’ windows, but then it ends. Nobody wants any more credit. They don’t care if they’re free. They can’t find a use for it. Production of credit ceases. It takes years to work through the overhanging supply of credit. Interest payments collapse, banks close, and unemployment soars. The economy is wrecked. People can’t afford to pay interest on their debts , so many bonds deteriorate away to worthlessness. The value of credit – at best – returns to the level it was before the program began.

This is exactly the situation we have in the US. People took on way more credit than they could ever pay off. They have over borrowed, over spent, over consumed. The contraction we see now is the deflationary payback for years of unprecedented profligacy. When people have had enough of something, they’ve had enough. Jaguars? Anyone?

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CMBS Talf Launches – Nobody Cares

A few days ago the Fed said most eligible CMBS OK for TALF:

Most commercial mortgage-backed securities eligible under published guidelines for the Term Asset-Backed Securities Loan Facility will also meet other Federal Reserve criteria, the Fed told investors on Friday, according one investor and a dealer.

Uncertainty over which CMBS could still be rejected from the TALF program next week has created confusion and capped gains in the $700 billion market, which the Fed wants to help unlock with the lending program.

The assurance by the Fed “will help, but we expect the market will be cautious,” Citigroup analysts said in a research note obtained by Reuters.

CMBS derivative index prices rose after the Fed conference call, according to one investor.

Today the program launched, and Investors request $669 mln in TALF loans for legacy CMBS:

Investors requested $668.9 million in loans for legacy commercial mortgage-backed securities on Thursday in a slow start for a key government program aimed at reviving the commercial real estate market.

The Fed is offering loans to investors for commercial mortgage-backed securities under its Term Asset-Backed Securities Loan Facility, or TALF, in an attempt to revive markets both for new and existing commercial bonds.

Lowering lending costs in commercial real estate could help ease refinancings by borrowers, who are increasingly defaulting on loans for a lack of credit.

Thursday was the first time the Fed accepted existing bonds under the TALF and the second round for its newly issued CMBS TALF program.

Investors did not request loans for newly issued CMBS in June or July.

It seems like CMBS TALF is off to a slow start. $668 million out of $700 billion is a drop in the bucket. Don’t expect it to pick up significantly. Commercial property lenders are loaded with non performing loans, precisely because lessees are going out of business or are unable to make their full payments. Demand for new loans is dried up. As I explained before, what the initiators of this program are missing…

(…)is the fact that the consumption credit expansion has brought about an abundance of retail space in malls, shopping centers and elsewhere. On top of that, a lot of businesses from the lending business were utilizing a significant portion of prime office space.

Now those businesses that were utilizing these spaces are going out of business. The recession is trying to send a signal that the resources are needed elsewhere. They are unable to make their rent payments. The owners of the properties start defaulting on the loans made during the credit expansion. The lenders notice that way too much space was built. There is no demand for any more retail space. In fact, there is a significant surplus. Nobody wants any more retail space. People are sick and tired of debt and over consumption.

Now, what are those very lenders going to do when they receive additional loans from the Fed, at around 2.9% to 3.7%, maybe even more for higher maturities. So they would have to earn at least an additional 100 basis points, probably more, in rental yield in order to make this investment worth their while, and that over the next 3-5 years.

Is this going to happen in an environment of falling prices for commercial properties, falling rents, and record vacancies? No, absolutely not. When people have had enough of something, they’ve had enough. If this is still not clear, I would recommend reading Robert Prechter’s example on Jaguar Inflation which I posted in Inflation and Deflation Revisited.

CMBS TALF will be a miserable failure, just as all other lending facilities launched by the Fed. It is possible that this failure will actually expose the dire situation of commercial lenders and accalerate the downward spiral. Thus, look out for the aftermath of first CMBS TALF auction on July 16th. Rather than it being a cure, it is likely that it will usher in a significant acceleration of commercial property loan defaults.

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Invent New Lending Facility, Fail, Repeat…

In a hopeless effort to boost consumer borrowing Treasury, Fed Announce Details on TALF Program:

In carrying out the Financial Stability Plan, the Department of the Treasury and the Federal Reserve Board are announcing the launch of the Term Asset-Backed Securities Loan Facility (TALF), a component of the Consumer and Business Lending Initiative (CBLI). The TALF has the potential to generate up to $1 trillion of lending for businesses and households.

The TALF is designed to catalyze the securitization markets by providing financing to investors to support their purchases of certain AAA-rated asset-backed securities (ABS). These markets have historically been a critical component of lending in our financial system, but they have been virtually shuttered since the worsening of the financial crisis in October. By reopening these markets, the TALF will assist lenders in meeting the borrowing needs of consumers and small businesses, helping to stimulate the broader economy.

Under today’s announcement, the Federal Reserve Bank of New York will lend up to $200 billion to eligible owners of certain AAA-rated ABS backed by newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans. Issuers and investors in the private sector are expected to begin arranging and marketing new securitizations of recently generated loans, and subscriptions for funding in March will be accepted on March 17, 2009. On March 25, 2009, those new securitizations will be funded by the program, creating new lending capacity for additional future loans.

The program will hold monthly fundings through December 2009 or longer if the Federal Reserve Board chooses to extend the facility.

Today the Board also released revised terms and conditions for the facility and a revised set of frequently asked questions. The revisions include a reduction in the interest rates and collateral haircuts for loans secured by asset-backed securities guaranteed by the Small Business Administration or backed by government-guaranteed student loans. The modifications are warranted by the minimal credit risk on these assets owing to the government guarantees, and, by making the terms of the TALF loans more attractive, they should encourage greater flows of credit to small businesses and students.

Additional details of the TALF and the CBLI can be found at www.FinancialStability.gov. Further information on the Federal Reserve’s credit and liquidity programs is available at www.federalreserve.gov/monetarypolicy/bst.htm. The Treasury Department also released a new white paper outlining efforts to unlock credit markets.

On February 10, 2009, the Board and Treasury announced an expansion of TALF to include new asset categories that could generate up to $1 trillion in new lending. Teams from the Treasury Department and Federal Reserve are analyzing the appropriate terms and conditions for accepting commercial mortgage-backed securities (CMBS) and are evaluating a number of other types of AAA-rated newly issued ABS for possible acceptance under the expanded program. The expanded program will remain focused on securities that will have the greatest macroeconomic impact and can most efficiently be added to the TALF at a low and manageable risk to the government.

The Federal Reserve and Treasury currently anticipate that ABS backed by rental, commercial, and government vehicle fleet leases, and ABS backed by small ticket equipment, heavy equipment, and agricultural equipment loans and leases will be eligible for the April funding of the TALF. Other types of securities under consideration include private-label residential mortgage-backed securities, collateralized loan and debt obligations, and other ABS not included in the initial rollout such as ABS backed by non-auto floorplan loans and ABS backed by mortgage-servicer advances. As is the case for the current categories of newly originated loans, the TALF will combine public financing with private capital to encourage the private securitization of loans in the asset classes eligible in the expanded program.

Increased TALF lending and other actions to stabilize the financial system have the potential to greatly expand the Federal Reserve’s balance sheet. In order for the Federal Reserve to conduct monetary policy over time in a way consistent with maximum sustainable employment and price stability, it must be able to manage its balance sheet, and in particular, to control the amount of reserves that the Federal Reserve provides to the banking system. The amount of reserves is the key determinant of the interest rate that the Federal Reserve uses to pursue its monetary policy objectives. Treasury and the Federal Reserve will seek legislation to give the Federal Reserve the additional tools it will need to enable it to manage the level of reserves while providing the funding necessary for the TALF and for other key credit-easing programs.

“The program will hold monthly fundings through December 2009 or longer if the Federal Reserve Board chooses to extend the facility.” – Let me take a wild guess: The facility will fail to boost lending. Mr. Bernanke will then conclude that it did not push enough money into the market and extend it. This is what the Fed has been doing again and again over the past 1.5 years:

In addition to the daily Securities Lending program, the Bank provides Treasury general collateral financing through the Term Securities Lending Facility (TSLF) and TSLF Options Program (TOP) to promote liquidity in Treasury and other collateral markets and thus foster the functioning of financial markets more generally. Weekly TSLF auctions offer Treasury securities held by the System Open Market Account (SOMA) for loan over a one-month term against program-eligible general collateral. The TOP offers options to borrow Treasury securities against program-eligible collateral over a short term that crosses key financing dates. Securities loans and options on securities loans are awarded to primary dealers based on competitive single-price auctions.

The Primary Dealer Credit Facility 03/16/2008:

The Federal Reserve has announced that the Federal Reserve Bank of New York has been granted the authority to establish a Primary Dealer Credit Facility (PDCF). This facility is intended to improve the ability of primary dealers to provide financing to participants in securitization markets and promote the orderly functioning of financial markets more generally.

Commercial Paper Funding Facility 10/07/2008:

The Federal Reserve created the Commercial Paper Funding Facility (CPFF) to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF is intended to improve liquidity in short-term funding markets and thereby contribute to greater availability of credit for businesses and households. Under the CPFF, the Federal Reserve Bank of New York will finance the purchase of highly-rated unsecured and asset-backed commercial paper from eligible issuers via eligible primary dealers.

Money Market Investor Funding Facility (MMIFF) 10/21/2008:

By facilitating the sales of money market instruments in the secondary market, the MMIFF should improve the liquidity position of money market investors, thus increasing their ability to meet any further redemption requests and their willingness to invest in money market instruments.  Improved money market conditions will enhance the ability of banks and other financial intermediaries to accommodate the credit needs of businesses and households.

Since March 11th 2008 the Fed has announced one ill conceived lending facility after another. Ben Bernanke has issued one assurance after another. He is puzzled as to why credit is still not flowing. All he can conclude that the Fed needs to push harder. But lending can’t be forced. One question that Bernanke should ask himself is: Do people actually want to borrow more? People are sick and tired of more debt. Banks aren’t lending because people don’t want to borrow. Businesses aren’t selling consumer goods because Americans are done consuming. And they won’t consume more for a long time. Quite the opposite, people will continue to cut back.

All efforts by the Fed and the Treasury to “jumpstart” consumption and borrowing again will fail miserably, whether one likes it or not.

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