Fed attempts to kick-start credit markets

THE US authorities aim to bring the credit markets back to life by dramatically expanding Federal Reserve lending to investors such as hedge funds – to up to $1,000 billion – in the hope this will plug a giant funding gap in the economy.

The move marks an escalation in the US central bank’s strategy of bypassing the dysfunctional banking system to provide financing directly to markets for consumer and corporate credit.

Officials say they have been forced to adopt this approach because efforts to improve liquidity in the banking system – while successful in reducing funding stress for individual banks – have not spilled over into wider credit markets.

“Unless we restore the flow of credit, the recession will be deeper and longer,” said US treasury secretary Timothy Geithner when revealing his plans.

In the past decade, a large part of consumer debt such as mortgages, car, credit card and student loans has been financed by the sale of securities backed by such loans. In 2007, before the credit crunch took hold, over half of the $5,655 billion borrowed in the US credit markets was financed through asset-backed securities.

Although banks in many cases arrange the original loans, they typically repackage them and sell them as securities to investors. This allows them to make more loans than the size of their balance sheets would allow. Such securities, particularly those backed by risky mortgage loans, have lost trillions of dollars in value. This has frozen the market for these securities and contributed to further falls in house prices.

With the markets dysfunctional, people and companies are finding it hard to borrow money, making the recession more severe.

In an attempt to kick-start the asset-backed securities market, the Fed plans to expand the $200 billion it has already earmarked to lend to investors such as hedge funds on favourable terms to as much as $1,000 billion.

The Fed hopes investors will use the loans – called the Term Asset-backed securities Loan Facility (Talf) – to buy securities backed by car loans, credit cards and student loans, as well as commercial real estate loans, mortgages loans, loans to small business and possibly municipal lending.

“The Talf could be a promising bridge to get the new issue market going again,” said Andrew Peisch, managing director at Deutsche Bank.

The Talf plans, however, rely on an untested model and there could be operational difficulties. And, with hedge funds under pressure as investors pull out money due to widespread losses, any investments that go sour could leave taxpayers footing a large part of the bill. –(Financial Times service)