Have you noticed how it has become difficult to get credit cards and loans these days?
Banks are increasingly reluctant to lend out money to people, as a lot of the loans that banks made went bad, and caused a lot of pain.
In the past, banks were able to loan out money to ordinary people like you and me, and then bundle these loans together and sell them off to investment bankers and hedge funds. This bundle was called – Asset Backed Securities and the whole process was called debt – securitization.
So banks were able to sell off your mortgages to hedge funds, raise money and then create new mortgages and allow greater credit to flow through the economy.
As you can well imagine, hedge funds lost their appetite for such Asset Backed Securities and as a result banks are also more reluctant in loaning out funds for credit cards and such. Ultimately that means that people have lesser money to spend and that leads to a downward spiral in the economy.
The Role of TALF
TALF stands for Term Asset Back Securities Loan Facility – and this program has been started by the Fed to get credit moving through the economy again. It will do this by providing cheap finance to hedge funds and other financial companies to buy – AAA rated Asset Backed Securities from banks, and in turn get banks to lend money to consumers again.
Important Facts about TALF
- TALF will cover auto loans, student loans, credit card loans or small business loans guaranteed by the U.S. Small Business Administration.
- TALF loans will only be made available on new lendings by the banks.
- TALF loans will only be given out for Asset Backed Securities that are rated — AAA, by two or more rating agencies.
- TALF will make loans till Dec 2009, and will be reviewed at that time.
- If someone wants to avail funds from TALF, then they will have to comply with the Executive Compensation Standards that have been recently set up by the US Government.
- TALF loans will be — one-year non – recourse loans. A non – recourse loan means that the bank that borrows under TALF is not personally liable for the loan. If there is a default on the loan, then the Fed can seize the underlying asset, example – credit card loan and then hope that their loan is fully repaid.Â If the market value of the asset is less than what the Fed has loaned out then the Fed will have to bear the losses.
The terms of TALF are really easy on the lenders and the terms have been kept in this manner to entice them to lend and get credit going through the economy again and give a kick-start to spending.
The whole root of the current crisis was easy money and cheap credit financing. This seems to be more of the same thing and while this may boost lending in the short – run, it is unclear how the impact of TALF can be any different in the long – term.