Earlier this week, I responded to an article on TALF in the WSJ by Alan Blinder
Since then, the FRBNY has released additional information and I’ve modified, slightly, my response to address the information in the release. I sent the following into Scott Lanman in response to his article in Bloomberg entitled, “Fed Steps Back From February Plan to Start TALF Loans “
As an aside, I don’t actually think the FRBNY has “stepped back” on TALF. My read of the releases, November, December and this most recent, all indicate that the program was due to start in February. I don’t see anywhere that they have pulled back from that date.
Here is my take on TALF. It is not going to accomplish what our government proposes it will accomplish. And I believe they know it.
While I agree with Mr. Blinder’s opinion that “a market by market approach makes a start on a cure”, I vehemently disagree that TALF “offers a transparent rulebook”.Let’s all agree on one thing. It was the banking industry failure to apply safe, sound and prudent underwriting criteria to mortgages they issued over the last six to ten years that created the economic crisis we are in today. Zero down payments, no income verification, no loan to value standards. They knew they would be divesting themselves of the risk when they sold these loans through mortgage backed securities. The direct result of this act was the devastation of our country’s economic foundation, which was previously built on a level of confidence and faith and trust in our banking institutions. (Our regulators also failed us when they allowed the banks to continue in this manner in direct violation of Regulation H….. but that story is for another day).Prior to the age of securitization, banks funded loans through balance sheet activities. They underwrote the credits and held the risk as their own. Securitization of assets was designed to allow for off-balance sheet funding of loans, provide investors with a reasonable return on their investment with a measurable and reasonable risk and provided the overall credit market with reduced funding costs that perpetuated the lending cycles. It was brilliant. Until it was abused. Now, because of the banking industry’s greed, there is no more CONFIDENCE in the assets being underwritten by banks, and that is across all categories and specifically those loans that TALF will fund: Credit Cards and Auto Loans.With respect to credit cards and auto loans, I am absolutely certain that the banks are still not applying any income verification to these loans. I tested they system with a car loan and a credit card loan and both were approved based on falsified information and therefore, only on credit score. No income verification was applied and no debt to income measurements were applied. You can read my report here: http://anonymousbanker.com/?p=42Until our government ensures that the banks start to apply reasonable credit underwriting guidelines to all forms of credit (yes that means income verification for all loan requests and an understanding of the consumers debt level in relation to their income), investors will never have any confidence in asset backed securities absent a government guarantee. And I, for one, do not want my tax dollars to go towards any program that absolves the banks of their responsibilities to the public and to this country by perpetuating their lax credit standards. We need confidence based on the quality of the underlying loans and not based solely on the government guarantee. Without addressing credit underwriting standards, the TALF program is simply just another bail-out program designed to transfer existing and new credit risk from the banks, through the investors and then onto the taxpayer by virtue of the new government guarantee.Additionally, the transparency that Mr. Blinder states he sees in the TALF program is, in my opinion, distressingly absent. In fact, the word I would use to describe the Federal Reserve Board’s release on the T.A.L.F program is …
Duplicitous: given to or marked by deliberate deceptiveness in behavior or speech.
Let’s look at the proposal: What is a non-recourse loan? Non- recourse means that the F.R.B.N.Y takes the bundle of loans that were underwritten by the banks without any income verification as direct collateral to their loan to the investor. If too many loans default, and the investor is unable to meet the principal and interest payments due to the FRBNY, then the F.R.B.N.Y will seize the collateral. This simply means the FRBNY will take ownership of the consumer and small business loans. The F.R.B.N.Y’s recourse is limited to the value of that collateral, which consists of the original loans made by the banks to the consumer and small business. This system of non-recourse lending puts the F.R.B.N.Y in the first-loss position with these bundled loans, not the investors and certainly, not the banks!
Non-recourse financing only protects a lender that utilizes prudent underwriting guidelines and, by its very nature, encourages them to only lend a reasonable percentage of the collateral value.
Banks that originate the consumer and small business loans, cannot directly borrow from the FRBNY to securitize these loans. What this means, is that they can’t make new toxic loans or take existing toxic loans they currently have on their books, and borrow through TALF to securitize them ……within the same transaction. What does this really mean? Let’s say that Chase bundles up $20 million in loans they originated. And Bank of America bundles up $20 million in loans that they originated. Chase could not use their loans as collateral to borrow through the TALF program. But there is nothing to STOP THEM from selling their $20 Million in toxic loans to Bank of America through the program. And in turn, Bank of America could sell their toxic loans to Chase through the program. In truth, the TALF program COULD be used to simply ‘launder’ the toxic loans between the banks that are already receiving funds from the Emergency Economic Stabilization Act of 2008. And I think that ‘launder’ is exactly the right word because this process will allow the banks to take the toxic loans off their books, pass them through the TALF program, and bring them back onto their books, nice and clean and fully guaranteed by our taxdollars!!!
This loophole does nothing to encourage the banks to improve their credit underwriting standards. Furthermore, TALF fails to require banks to direct the funds they receive, when they sell the loans, back into the market in the form of new loans. The government is assuming that the banks will do this on their own. Our government also assumed that the capital they injected into the banks would be directed towards lending and the bankers have basically hoarded those funds. Without clear direction, the banks cannot be counted on to meet the underlying intentions of TALF and improve credit availability to the public.Further examination of the TALF program must make one focus on its definition of the term “recently originated”. The latest FRBNY release states that: Auto loans must be originated after October 1, 2007; Small Business Association (SBA) loansafter January 1, 2008; student loans must have had a first disbursement date after May 1, 2007; and for credit card loans, the new asset backed security must be issued to REFINANCE existing credit card Asset-Backed Securities that MATURE in 2009. That’s the worst rule of all because it doesn’t matter when these credit card accounts were initially granted. It permits banks to transform old toxic credit card debt that’s on the bank’s books into government guaranteed credit card debt.TALF also states that eligible collateral must have a long-term credit rating in the highest investment grade category. There is an apparent contradiction of terminology: “recently originated” and “long-term credit rating” are mutually exclusive terms. You can’t be both at the same time.On Feb 6th, the FRBNY finally released the conditions for what they call the “haircut”, that portion of risk that will be borne by the investor. For credit cards, it ranges from 5% to 11% and for auto loans, it ranges from 6% to 16%. When a bank grants credit to a small business to purchase commercial real estate, first, as an abundance of caution they almost always require the personal guarantees of the owners. In the larger commercial loan transactions, these loans may be granted on a ‘non-recourse’ basis, but then the loan to value is almost certainly 80% and more often than not, 60% to 70%. If this is standard for bank non-recourse lending secured by real estate, why then would our government agree to a lower percentage for unsecured debt.Additionally, when banks make real estate loans they calculate cash flow or capacity to repay on the property and take into consideration a vacancy rate. Prudent lending practices govern this process. Through TALF, our government is guaranteeing loans on which the banks have not performed the most nominal form of income verification, and then they propose to apply a loan to value of between 95% and 84% when using these loans as collateral. This is not prudent application of our tax dollars!My final observation is that T.A.L.F does not clearly define how that $200 Billion dollars must be allocated between the various loan types: student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. Since S.B.A loans, by their very nature, carry a government guarantee of between 50% and 75% to the banks, then isn’t there a double guarantee under this program? One guarantee from the S.B.A and one under T.A.L.F? It doesn’t seem possible that the government wants to give two guarantees on the same loan! If they are unconcerned about this, it is because they KNOW that the TALF funds will NOT BE USED to stimulate SBA financing by the banks.More to the point, however, is that if the program doesn’t require the banks to allocate a percentage of these resources specifically for S.B.A. lending, it is unlikely that the banks will increase their S.B.A lending functions. They will direct these resources to the other unsecured loan categories that carry higher interest rates and therefore higher immediate returns upon their sale under TALF.
I understand what the Federal Reserve Board is trying to accomplish, and applaud it for its efforts. I just think they should be more transparent and forthcoming in the way they describe the plan. And our leaders should finally realize that the ones that have the money, and ability to commit our taxpayer dollars, get to make the rules. This program, absent major re-regulation of the lending procedures currently used by banks; and minus a clearly defined requirements on allocation of these funds, is just another accident waiting to happen.
If this program was designed to meet it’s fundamental goal: to increase confidence in the Asset-Backed Securities market so that banks would once again lend to the consumer and small business, here’s what they need to do.
- Make the TALF funds available ONLY as a means to finance newly generated loans- specifically loans issued after January 1, 2009, and for those loans issued in compliance with the newly defined credit underwriting standards set above.
- Require that the proceeds from the sale of loans sold through the TALF program be put BACK into these same types of loans so that banks cannot merely divest themselves of loans already on their books and hoard these new funds.
- Enact legislation that will impose credit underwriting standards on the banks that make the loans. This policy will create confidence in the loans that are being granted and subsequently sold. Confidence based on the actual value of the loan and not based on a government guarantee. The guarantee would be gravy.
- The program must direct specific amounts of the TALF funding towards specific loan categories such as SBA loans. Without such direction, banks will simply focus on credit cards and other loans that have higher interest rates and that will provide them with higher levels of immediate income. Nothing will be done to help the business owners in this country.
Over the course of this crisis, we have maintained that the confidence in the banking industry and its leadership has been thoroughly eroded. Confidence in our political and regulatory agencies has also vanished. As long as there is no confidence, there can be no recovery. The Federal Reserve Board’s apparent dissemblance in its presentation of the T.A.L.F program will simply make things worse. False assurance is worse than no assurance. Transparency is more than a virture, it’s a necessity, and the devil in the TALF lies in its details, or lack thereof.