Another Day, Another Bailout: Deleveraging Denial

Another day, another bailout, another $800 billion and in the end I’m left scratching my head asking, Why? What is the grand plan here? Is there a plan at all?

Let’s take apart today’s new plan.

The Fed is going to lend up $200 billion of recently issued asset-backed securities collateralized by student loans, auto loans, credit card loans and SBA guaranteed loans. This new facility is to be known as TALF. The rationale for the program as enunciated by the Fed goes like this:

New issuance of ABS declined precipitously in September and came to a halt in October. At the same time, interest rate spreads on AAA-rated tranches of ABS soared to levels well outside the range of historical experience, reflecting unusually high risk premiums. The ABS markets historically have funded a substantial share of consumer credit and SBA-guaranteed small business loans. Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity. The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads.

There are a couple of things in the statement that really sort of grind on me.

First, it states that interest rate spreads have risen to ranges outside the norm of historical experience due to disruptions in the ABS market. Note that they neglect to go into any detail as to what period was used to establish the “normal risk premium”. Is it a range that was calculated over a 10, 20 or 30 year period or is it one that was derived over the past five or six years of unusually low interest rates? Could it be that current interest rate spreads just reflect a new view of appropriate risk pricing on the part of buyers of asset-backed securities? Or is the Fed arbitrarily determining what the cost of a particular type of credit should be?

Second, the statement clearly expresses dissatisfaction with the current amount of credit being delivered by the market to these sectors. It seeks to blame the perceived shortfall as resulting from a dysfunctional market. Maybe, but I thought that there was general agreement that the nation as a whole was over leveraged. The statement gives the impression that the government wants to roll back the clock. If the economy is being starved due to an absence of credit then fine, something probably needs to be done. If, on the other hand, we are seeing a restriction of available credit due to tighter, saner underwriting then I fail to see the point.

Moving on, the second part of the press release says that the Fed will buy $100 billion of direct obligations of Fannie (FNM), Freddie (FRE) and Ginnie Mae and launch a program to purchase up to $500 billion of their mortgage backed securities. Once again old Mr. Market is being blamed for not working right and the goal is to reduce the cost of credit and increase the availability.

I don’t want to beat a dead horse here, but underwriting standards are mostly to blame for fewer home loans. Yeah, the spreads are historically higher, but if I were an investor in mortgage backed securities listening to Barney Frank and Chuck Schumer promising to let the bankruptcy courts cram down my debt, I’d be demanding a higher interest rate too.

Let’s cut to the chase here. The latest move to shore up the mortgage market is just a circular way of providing direct federal government financing of mortgages. The artifice is that Fannie, Freddie and FHA are making the loans, while in fact they are simply conduits to the Treasury. The complete nationalization of the mortgage business in America is complete.

Deleveraging is going to happen whether the government likes it or not. The recent moves are simply the machinations of tired men who are starting to run out of options. I’ve said that before and each one of these new programs just reinforces the concept. Let’s hope a new administration recognizes the pain that the country has to endure. Let’s also hope that they respect the market a bit more and recognize that sometimes the signals it sends represent may represent a new paradigm not a malfunctioning market.

Comments

[Steve15:]

They mean exactly what they say, when they are talking about credit spreads for the AAA ABS market. If you had any knowledge of this market, you would know that these spreads are at ALL time highs (not just relative to the past couple of years). I agree with your points about deleveraging, and how the whole nation was too highly levered at one point. This also doesn't mean that nothing needs to be done. Someone (i.e. the govt) needs to step in to shore up the credit markets so that they start functioning more appropriately sooner. If no one steps in, it could utimately lead to further destruction or collapse of the financial markets.

2008 Nov 26 07:38 AM

[johnbee:]

Perhaps I'm a bit naive here but I don't understand why the Government needs to print money to buy toxic assets or pay Fannie Mae etc.
Why can't it simply guarantee all mortgaged domestic properties up to a value of 80% of the home based on a local government rating assessment?
This would cost nothing so long as the mortgagor remained solvent, and the guarantee should assist this greatly and give depositors a better feeling of security so as not to withdraw banked money and put it into Treasuries or under the bed. Am I wrong or what?

2008 Nov 26 09:49 AM

[Smarty_Pants:]

The FED and USTreasury are making up the rules as they go.

"Save these guys but not those except on odd Wednesdays, or holiday weekends, or if they're 'too big to fail', or if one of my old Wall St. buddies is CEO."

They are attempting to put out a forest fire with a squirt gun, claiming all the while that the fire truck will be here at any moment. The reality is that the fire truck doesn't exist.

As the author points out, the deleveraging will continue. It is too big to be stopped. Trying to avert the inevitable will only spread the pain to those who acted prudently in the past instead of letting only those who acted foolishly suffer the results of their prior choices.

As is noted many times in other places on SeekingAlpha, you can't borrow your way out of debt.

2008 Nov 26 11:20 AM

[Tom Lindmark:]

Steve,
Thanks for your comments but one observation. If I'm not mistaken the ABS market is relatively new so any historical comparisons suffer from the fact that they represent an easy money period. If the statistics went back 20 or 30 years or more, I might be inclined to agree that they are at an all time high. Right now, they may well be simply representing an acknowledgement of the risk inherent in the product.

2008 Nov 26 11:30 PM

[DollarTalk:]

I am very thankful for the blessings that I have in my life. Now, regarding the market, the power of optimism never ceases to amaze me. In fact, we are missing a very large component of our view on the market and the economy in larger view when we discount the role of perception. Most of this market volatility was brought on by increased uncertainty and the perception that our credit crisis and financial difficulties were beyond our ability to solve as a free market. This, of course, was exacerbated by the media and capitalized on by the media in order to accomplish the election of now President-elect Obama. Now, the media has their man and would do well to continue to promote positive, uplifting views on the future direction of the economy and the solutions and people proposed by President-elect Obama. Otherwise, they will find themselves in the company of the Republican party when the public develops a pessimistic or negative perception of the new President and his leadership team. That's all for now. More on my blog.

2008 Nov 27 01:59 AM