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U.S. to Invite The Wealthy To Invest in The Bailout

"Our members have significant interest," said Richard Baker, president of the Managed Funds Association, the leading association for hedge funds. "The plan recognizes that our industry can bring significant resources to bear."

Here's how a typical TALF deal would work: A hedge fund uses $1 million of its own money and gets a $9 million loan from the Fed, payable after three years, to buy a $10 million asset-backed security, which finances consumer loans. Hoping that the market for these assets recovers, the hedge fund would hold the asset for three years.

If the security rises in value to $11 million, the investor would keep the profit, essentially doubling the initial investment. The government, meanwhile, would consider the deal a success because consumer lending was spurred.

If the value fell below $9 million, the hedge fund would lose its down payment but nothing more. The Treasury, using bailout funds approved by Congress, would cover the next set of losses, with the Fed ultimately on the hook for anything more.

Steven Schwartzman, chief executive of private-equity giant Blackstone, said the program is "highly attractive" because of the government financing.

The TALF's primary aim is to get the "shadow banking system" running again. A vast portion of the financing for loans issued in the United States comes not from traditional banks but from other enterprises.

Some firms that issue consumer credit questioned the program's limitations. Executives at one leading bank said restricting the program to securities backed by only the highest-quality loans would be too constraining.

For example, many loans taken out by auto dealerships to stock their inventory do not have the highest ratings. Government officials, who want to make sure dealers can get these loans, are considering expanding the TALF to slightly lower-quality assets, sources said.

Some officials are concerned there may not be enough highly rated loans that can be combined into securities to sell to investors.

Another matter of discussion among federal officials is whether to lengthen the term of the financing extended by the government to investors, sources said. With securities backed by auto loans, for example, a relatively short period was deemed appropriate because these loans mostly carry three-year terms. But when the TALF expands in the coming months to aid other segments of the credit market, such as commercial real estate loans, the Fed may have to lengthen the time because such loans carry 10-year terms or longer.

If Fed and Treasury officials decide to extend the TALF model to the purchase of toxic assets, this would require expanding the approach from recently issued loans to those that are years old.

Each step away from the original target of the TALF -- recently issued, highest-quality assets -- may force the government to protect itself, which would involve offering less to private investors, officials said. But if the government goes too far in shielding itself, it may fail to generate interest by private investors. Striking the right balance -- among lenders who issue loans, investors who buy them and taxpayers who are facilitating the transactions -- has been one of the greatest challenges in developing the program, officials said.

Staff writers Neil Irwin and Binyamin Appelbaum contributed to this report.


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