Fed Moves to Free Up Credit for Consumers Article

By LIZ RAPPAPORT and JON HILSENRATH The U.S. launched a program to finance up to $1 trillion in new lending to consumers and businesses, in an ambitious attempt to jump-start credit for everything from car loans to equipment leases. The Federal Reserve and the Treasury Department hope to revive the moribund market for so-called securitized lending, which until last year was central to providing consumer and business loans. Starting March 17, large investors -- including hedge funds and private-equity firms -- can obtain cheap credit from the Fed and use the money to buy newly issued securities backed by such loans. The Fed, which announced the program's outlines in November in tandem with the Treasury, had already expanded the size of the program and on Tuesday further expanded its targets. Originally limited to backing securities for consumer and small-business loans, it now will also target securitized loans for heavy industrial equipment, agricultural-equipment leases and rental-car fleets. And the central bank sweetened some terms to draw investors and debt issuers. For instance, participants won't have to adhere to limits on executive compensation that apply to banks that accept bailout government money. Such restrictions were originally planned for some participants. Much is riding on the initiative, known as TALF for Term Asset-Backed Securities Loan Facility. At the height of the credit boom, Wall Street issued more than $1 trillion a year of securities that were backed by consumer credit, and trillions more backed by mortgages. These markets -- sometimes called "the shadow banking system" because they operate outside traditional bank activity -- accounted for roughly 40% of all consumer lending before the financial crisis erupted last year. But the market dried up last year. Issuance of securities tied to consumer loans dropped to less than $8 billion in the final three months of last year. Heard on the Street The Fed Goes for Brokerage"There has been somewhat of a collapse of the banking system, but an almost total collapse of the shadow banking system," said Princeton University economist Alan Blinder. "Given our reliance on the latter, we need to get that shadow banking system revived." Investors greeted Tuesday's announcement with a mix of enthusiasm and skepticism. "You need a robust securitization market to reestablish a broad lending platform in the society," said Stephen Schwarzman, chairman of private-equity firm Blackstone Group LP, which is considering investing through the Fed's program. Mr. Schwarzman said he expects the plan to be successful at bringing investors back into these markets. The first test of the program is likely to come from a privately held consumer-finance firm, World Omni Financial Corp., which makes loans through Toyota Motor Corp. car dealerships mostly in the southern U.S. World Omni is preparing to bundle more than 25,000 loans attached to passenger cars, minivans and SUVs to create as much as $750 million of securities backed by those loans. It will then turn to the Fed to make three-year loans to investors who buy the securities. Ben Bernanke World Omni declined to comment on the pending financing. The program's effectiveness could be crucial for the auto industry, which had its worst sales decline ever in February. Still, strict rules on creditworthiness may disqualify many securities tied to auto loans. (See related article) Bankers say there are at least 10 more offerings in the pipeline, many expected from auto-finance companies. Barclays Capital, which is advising World Omni on its TALF issue, said it hopes to sell two or three more offerings by the TALF's March 25 first-round deadline. The generous terms -- structured to let investors earn double-digit returns with limited downside risks -- have led some hedge funds such as Millennium Capital Management, Cerberus Capital Management and Fortress Investment Group to consider participating. But Bill Gross, co-chief investment officer at bond shop Pacific Investment Management Co. in Newport Beach, Calif., warned the program may be a bit late in its launch and won't reach its $1 trillion capacity given weak consumer demand. "It may be the same problem we have with banks," Mr. Gross said. "You can bring the horse to water, but they may not drink." Another obstacle for the program is that some lenders might find other funding sources, such as drawing in more bank deposits or issuing debt backed by the Federal Deposit Insurance Corp. The government, in essence, is trying to save the economy by turning to the very financial engineering that spun out of control during the credit boom. Both President Barack Obama and Fed Chairman Ben Bernanke have risked substantial political capital on the success of the program, expanding it beyond the original $200 billion and heralding it in speeches and congressional testimony. "This will help unlock our frozen credit markets, which is absolutely essential for economic recovery," Mr. Obama said in a speech Tuesday. Some worry the Fed is throwing out another short-term solution to a long term problem. Thomas Atteberry, a partner and portfolio manager at First Pacific Advisors LLC, which isn't planning to participate in TALF at the moment, said, "I'm not a big believer in this. There is a reason credit is contracting -- because the economy is in recession and banks typically raise their lending standards to protect their precious capital." Investors, who must request a minimum $10 million loan from the Fed, will take some risk, though it will be limited. In World Omni's case, for example, they will be able to borrow between $92 and $94 from the Fed for every $100 they put into the deal. The Fed will charge investors the London interbank offered rate, or Libor, plus 1 percentage point. Investors' ultimate return will depend on the final pricing of securities. Assuming no major losses on the underlying loans, World Omni investors are anticipating returns of between 12% and 16% a year over three years. One big carrot for the investors: They can walk away from a deal if they are unable to repay the Fed loan, losing only their initial investment. The Treasury's Troubled Asset Relief Program -- which is authorized to inject funds into lenders and buy their toxic assets -- will absorb initial losses, if any, limiting the Fed's exposure. To protect itself, the Fed is only providing financing for securities with AAA credit ratings. The TALF program is structured to allow the Treasury to leverage money Congress allocated for the TARP, and in turn allow the Fed to lend $200 billion for every $20 billion of TARP money it gets. But even with the Fed and Treasury protection, TALF investors could still endure losses, given the economy's weakness. For example, more than 40% of the loans expected to be part of the World Omni securities were generated in Florida, where the unemployment rate has risen to 7.6% from 3.5% in the past two years. Over that period, the firm has seen delinquencies and losses on its loan portfolios rise. Last week, Moody's Investors Service placed other auto-loan backed securities tied to World Omni on review for downgrade. The TALF, designed by Treasury Secretary Timothy Geithner while he was president of the New York Fed, was launched with the enthusiastic backing of Bush administration Treasury Secretary Henry Paulson. It was originally conceived for markets for such things as credit-card debt, student loans, car loans and loans guaranteed by the Small Business Administration. Its expansion extends the offer to entities such as car-rental companies and agricultural-equipment makers such as Caterpillar Inc. and Deere & Co. The Fed said it may expand the program to cover financial instruments known as collateralized debt obligations and corporate-loan investment vehicles that were widely used during the credit boom. The TALF's launch was plagued by delays and technical glitches. Sorting out how to play the role of investment banker -- from deciding what terms to offer on its loans to how to manage its back-office operations -- has been a huge and complicated task. Write to Liz Rappaport at liz.rappaport@wsj.com and Jon Hilsenrath at jon.hilsenrath@wsj.com