More than two months after the Treasury Department announced a "bold expansion" of the Term Asset-Backed Securities Loan Facility (TALF), nothing has happened and doubts are growing that anything ever will.

The Treasury has pledged to expand the TALF — which now only targets new auto, student and small-business loans — to include CMBS and, possibly, RMBS. It went even further last month, saying TALF would eventually accept so-called legacy securities that are weighing down bank balance sheets.

But the Federal Reserve Board, which is actually running — and financing — TALF, has made no move to lend against those securities and given no sign it plans to act anytime soon.

The delay is fueling concerns that the promised expansions may never become reality.

"I don't think there's much chance they can get it going," said Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial. "The climate has changed."

Representatives of the Treasury, Federal Reserve and Federal Reserve Bank of New York (which makes the TALF loans) would not comment on when the expansions might occur.
The Fed remains committed to the expansion, noting in its most recent policy statement that it "anticipates that the range of eligible collateral … is likely to be expanded." But the central bank faces a daunting task in reaching that goal, including deciding on haircuts that will protect the Fed but still prove enticing to investors.

Under the program, the Fed lends to investors, which use the money to buy securities backed by consumer loans. The goal is to liquefy the markets for consumer debt by providing an incentive for investors to buy the securities. Assets initially eligible for the program included securities backed by auto, credit card, student and small-business loans.

At least part of the problem with any expansion is the so far anemic interest shown in the initial program. The New York Fed received $4.7 billion of loan requests in March and just $1.7 billion during a second round this month. This makes it more challenging to expand the program, observers said, if there is already a sense that it is not working.

"They're having a hard enough time getting people to come to the dance they have going on now," said Bert Ely, an independent consultant in Alexandria, Va. "You almost set yourself up for embarrassment if you expand the program and people still don't come."

Several observers said the largest obstacle continues to be congressional threats to impose executive compensation restrictions on any entity that uses a government program. This has helped dampen interest in the existing program and has made many investors unenthusiastic about any expansion.

"Congress kind of dug their own hole by going after the AIG bonuses," said Scott Valentin, an analyst at Friedman, Billings, Ramsey Group.

Mark Pawlak, an analyst at KBW's Keefe, Bruyette & Woods, agreed that "pay restrictions would severely crimp the program."

"No matter how attractive the return is on an investment, if you are at the same time capping your pay or cutting your pay, you're going to look for alternatives," he said. "Given that a lot of these investors are hedge fund investors, I think the pay scale is something that would not be attractive to a hedge fund investor."

It is unclear whether pay restrictions would apply to the TALF. The stimulus legislation approved by Congress required a clampdown on executive pay at any company receiving bailout money.
Strictly speaking, however, the $1 trillion the Fed aims to lend through TALF does not stem from any congressional appropriation or the Troubled Asset Relief Program (TARP). William Dudley, the president of the New York Fed, tried to drive home that point during a speech on Saturday. "The lending to investors on the front end is completely a Federal Reserve program and operation," he said.

Still, the Treasury has pledged $100 billion of (TARP) money to cover losses that might arise from Talf. In congressional testimony Tuesday, Treasury Secretary Timothy Geithner added to the confusion by saying "we're going to apply the law" on executive compensation but without clarifying what this means for TALF.

Further complicating an expansion is a rapid deterioration in the CMBS market in recent months as the commercial real estate business suffers in the recession. Several observers said that market is far less stable than it was when the expansion was announced in February. "People have become much more fearful of commercial real estate," Valentin said. "You've seen prices decline dramatically. You've had a couple of distressed sales of trophy properties. Vacancy rates have gone up so there's a tremendous amount of price stress in the commercial real estate market right now and investors are unwilling to step in."

Unwilling to step in, that is, unless the Fed helps them. But getting into commercial real estate was already a controversial prospect in February. Doing it now, while also diving into the world of legacy assets, could be seen as even more risky.

Minutes from the March 17 meeting of the Fed's policymaking committee suggest that those fears are explicitly felt inside the central bank. "Some participants expressed concern about the risks that might arise from the possible extension of the Talf to include older and lower-quality assets, noting, in particular, the greater uncertainty over the value of such assets," according to the minutes.

The financial crisis has dramatically changed the look of the Fed's balance sheet, but Chairman Ben Bernanke has consistently argued that many of its holdings will slide off naturally or sell easily, loading the central bank with relatively few risks. But the situation is likely to be different for the three-year, nonrecourse loans made through the TALF.

"Buying mortgages and Treasuries and agency debentures — they're all very liquid assets, and if need be, there's an exit strategy for them," KBW's Pawlak said. "It's a little different than taking on RMBS … and CMBS and putting it on their balance sheet. There has been a concern within the Fed, which is probably well-founded, that they can't just turn around and wind down a portfolio of RMBS and CMBS."

To be sure, the expansions being considered are complex. The Fed took nearly four months to begin TALF's initial version — and it did not get into as many risky markets.
But observers said TALF's expansion is very important to the success of the Obama administration's overall efforts to clean up bank balance sheets and that it should be started before the ground shifts again.

"The difficulty is that you develop a program, and before you can even implement it, circumstances have overtaken it," said John Collins, a partner in Steptoe & Johnson. But "TALF is a centerpiece. … I don't know what plan B would be."

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