Tuesday, February 17, 2009

Geithner's Most Important plan element least discussed

The big problems are the big investment banks, not the traditional banks.  As a nation, we have had bank problems since the 2nd National Bank.  It may not be fun, but people know how to do this.

However, the huge amount of lending through securitization by investment banks is a new issue.  Per Geither:
Consumer & Business Lending Initiative – Up to $1 Trillion: Addressing our credit crisis on all fronts means going beyond simply dealing with banks. While the intricacies of secondary markets and securitization – the bundling together and selling of loans – may be complex, they account for almost half of the credit going to Main Street as well as Wall Street. When banks making loans for small businesses, commercial real estate or autos are able to bundle and sell those loans into a vibrant and liquid secondary market, it instantly recycles money back to financial institutions to make additional loans to other worthy borrowers. When those markets freeze up, the impact on lending for consumers and businesses – small and large – can be devastating. Unable to sell loans into secondary markets, lenders freeze up, leading those seeking credit like car loans to face exorbitant rates. Between 2006 and 2008, there was a net $1.2 trillion decline in securitized lending (outside of the GSEs) in these markets. That is why a core component of the Financial Stability Plan is:
A Bold Expansion Up to $1 Trillion: This joint initiative with the Federal Reserve builds off, broadens and expands the resources of the previously announced but not yet implemented Term Asset-Backed Securities Loan Facility (TALF). The Consumer & Business Lending Initiative will support the purchase of loans by providing the financing to private investors to help unfreeze and lower interest rates for auto, small business, credit card and other consumer and business credit. Previously, Treasury was to use $20 billion to leverage $200 billion of lending from the Federal Reserve. The Financial Stability Plan will dramatically increase the size by using $100 billion to leverage up to $1 trillion and kick start lending by focusing on new loans.
This is a major rationale for saving the investment banks.  However, this will be a challenge.

1.  People got burned badly the last time they bought securitized loans.  They won't make the same mistake again.

2.  The rating agencies will have to clean up their act.  Or perhaps just cut out of the process.  If the securities have a Treasury guarantee, the rating agencies aren't needed.

3.  The originators of the loans haven't had a paycheck in a while, and may not be around.  

4.  They have to make solid loans.  The demand for loans to buy motorcycles, boats, etc. may be modest.  The people most likely to borrow are least likely to qualify.

5.  The new securities need to be bullet proof, much simpler, more transparent, and contain more protection for purchasers.  A lot of the profit was made by cutting corners in all these areas.

6.  If the securities are simpler and the process is controlled by the Treasury, then maybe you don't need rocket scientists making them and costs/fees are significantly lower.

For these reasons, half of it isn't coming back.  


babar ganesh said...

do you have to have an investment bank to securitize a pool of loans?

it doesn't seem inherently difficult.

cap vandal said...

Yes and no. You need some expertise which isn't hard to find these days. You need the ability to fund assets while you assemble pools, a little harder. You need to find someone to buy them. Impossible without government backing. You need someone to figure out what to do with the equity and lower level tranches. Not much demand for those.

The idea is that if you want to "restart" the lending quickly, you need to keep some institutional continuity.

Longer term, the problem will be a shortage of buyers and I suppose the fed will have to back these to a considerable extent.