By Neil Irwin
Washington Post Staff Writer
Thursday, April 23, 2009
In its first two months, the government's signature initiative to support consumer lending has fallen well short of expectations, deploying only a fraction of the amount officials had hoped to extend to stimulate auto loans, student loans and credit card lending.
The slow rollout of the program has frustrated staff at government agencies working on the effort and diminished hopes that they could engineer a rapid return to healthy lending levels, according to interviews with government and industry sources. The initiative also serves as a window into the complexities of designing a giant rescue of the financial system.
Even without widespread use of the program, consumer lending has improved somewhat in recent weeks, and there are signs that the economy's free-fall is ending, raising questions about whether the program will ultimately be needed to get the economy going again.
But some private analysts and government officials attributed the improvement in credit availability in part to the mere existence of the program, which has bolstered confidence. They think that the Term Asset-Backed Securities Loan Facility, or TALF, once operating at full speed, will play an important role in unclogging the markets that fund consumer loans.
Under TALF, private investors such as hedge funds put up a relatively small amount of money to be matched with a larger loan from the Federal Reserve. The combined funds are then used to purchase newly created, highly rated securities, which in turn fund a wide range of consumer and business lending.
If the securities become more valuable, the private investors stand to repay their government loans and make a healthy profit; if the securities plummet in value, the investors can lose only what they put up originally, and the government is at risk of losing money on its loans, too.
Officials envisioned TALF supporting tens of billions of dollars a month in new lending, saying it could eventually total $1 trillion. But in March, when it was launched, it backed only $4.7 billion in auto loans and credit cards. For April, it logged only $1.7 billion.
Sources involved in the program said private investors have been reluctant to work with the government, which they view as an unreliable business partner. Separately, the brokerage houses that are crucial intermediaries are being exceptionally cautious in the contracts they draw up with participants in the program, in part out of wariness that any mistakes could draw the ire of Congress or the media.
In congressional testimony on Tuesday, Treasury Secretary Timothy F. Geithner said that overall progress is "pretty good" for a program in its early days. Still, he acknowledged that participation was "lower than expected" because of "concern about the conditions that come with the assistance in the program . . . and uncertainty about whether they may change in the future."
There are restrictions on the business activities of participants in the program. For example, investors who control more than 25 percent of a fund that benefits from the loans face restrictions on their ability to hire immigrants using H-1B visas.
But perhaps more significant than any established limitation on the business practices of TALF participants is a fear that the government could retroactively change the terms, exacting new limits on what investors can pay their executives, for example, or trying to claw back profits that firms make in the program. The recent outcry over bonuses paid to executives at American International Group has heightened those fears.
"The government is viewed as being unpredictable," said Warren Loui, a partner at the law firm Mayer Brown who has represented companies participating in TALF. "If the program is successful and the investor makes attractive returns, will the government want to come in and change the rules midstream?"
Federal Reserve officials have privately urged President Obama and congressional leaders to publicly state that the government views investors in voluntary programs such as TALF differently than it does companies that need a federal bailout.
Investors are not the only ones who need comforting, though.
The Fed relies on primary dealers, or brokerage houses, to play a key role as intermediaries in TALF, funneling the government loans to investors and holding on to the asset-backed securities as collateral.
But the primary dealers have been extremely cautious in designing their contracts with investors, hobbling the program's progress, said people who have been involved with the deals. Some primary dealers have sought to vet each investor in a hedge fund, for example, a huge undertaking.
"There's a distinction between due diligence and removing all types of business risk," said Gordon Baird, chief executive of Paramax Capital, a hedge fund that has invested through TALF. "I don't think any bona fide long-term investor has any problem answering and addressing real due-diligence questions, like knowing your client and anti-money-laundering steps. . . . The issue is things that go far beyond that." Some investors have been "asked to assume risk that goes beyond the original spirit of the program."
The Fed loans, for instance, are supposed to be "non-recourse," meaning that the investors who participate cannot lose any more than they put at risk. But an executive of a primary dealer, who spoke on condition of anonymity because he was not authorized to speak publicly, said his firm and others are trying to structure contracts such that if a deal goes sour, they can go after all an investor's assets, not just those put at risk through TALF.
Another issue is who would be on the hook -- the primary dealer or the investor -- if a trade fails.
"The primary dealers are taking a very defensive posture, trying to protect themselves," said a government official involved with the program who also was not authorized to speak publicly. "Part of it is just generally being cautious, and part of it is because they're afraid if anything goes wrong there will be political consequences and reputational risk."
Lawyers at the New York Fed, which executes TALF, have been working to help the brokers and investors work through the issues, and government officials are hopeful about the program's future.
Still, the challenges in getting TALF running at full speed show the difficulties facing the Treasury and the Fed as they design new programs to try to deal with the financial crisis. The Public-Private Investment Program, designed to buy loans and securities from banks, is structured similarly to TALF.
"The challenges they face with TALF are the same as those with PPIP," said Scott Talbott, senior vice president of the Financial Services Roundtable, which represents large financial companies.