President Barack Obama has been in office for less than a month. But already, there are a slew of new programs on the table slated to boost lending in the structured finance market and jumpstart new deal flow.
Market reaction has been favorable thus far. However, the success of these programs will depend on the particulars of the legislation.
Among the latest policies to hit the table is the proposal of a "bad bank," run by the Federal Deposit Insurance Corp. (FDIC), that would buy up illiquid assets, like MBS, in order to lighten bank balance sheets and spur new lending. The plan is likely to be used in tandem with the approximately $825 billion economic stimulus package, according to reports.
Structured finance market participants appear to be on board with the idea of a bad bank, citing the historic success of similar programs. After the Resolution Trust Corp.'s orderly disposition of failed assets during the Thrift crisis, and the disposition of bad assets from the insured banking system by the Home Owner's Loan Corp. during the Great Depression, the credit markets rebounded.
"Both of these organizations had finite terms. They acted, on both occasions, professionally and promptly to deal with distressed financial assets," said Michael Youngblood, a principal at Five Bridges Capital. "Those are very strong precedents that the market will understand and respond to favorably."
However, with the full range of proposals that the administration is putting forth, the market will not rally on one good proposal. Furthermore, a lot of the details have yet to be announced. One question that has not been answered is whether the bad bank will be part of the Troubled Asset Relief Program (TARP) or whether it will be a parallel initiative, Youngblood said. "How would the bad bank relate to TARP and other various funding programs put in place by the Federal Reserve and ongoing purchase programs put in place by Fannie Mae and Freddie Mac?"
The specific charter that is given by Congress could frustrate a program's success. For example, the HOPE for Homeowners program failed because it only applied to borrowers whose property was not encumbered by a second lien, Youngblood said. "The markets are hopeful; the markets are poised to respond favorably. But a proposal that is well intentioned may not necessarily be well executed by Congress."
In a bad bank scenario, there is also a longstanding concern regarding valuations. If the government purchases assets at the best value for the taxpayers, it may cause forced recognition of losses for other institutions and the potential for additional insolvencies across the financial system - which will require government capitalization. "That is why TARP didn't proceed in the way we thought it would and that is the problem now," said Ed Gainor, a partner at McKee Nelson.
Indeed, the Bush administration, when faced with the complexities of evaluation, decided to make preferred stock injections in commercial banks instead.
Gainor suggested that the government would need to combine a direct purchase program with capital infusions to cover the losses.
There has also been discussion about the administration leaving the assets on some of the bank's balance sheets by partially insuring them against losses, which would avoid valuation issues and doesn't have as much of budget deficit impact on the Government.
This will help resolve the uncertainty and confusion about bank losses, the depth of government involvement in banks, and fears of financial institutions becoming insolvent. Gainor said, "As long as this huge cloud of uncertainty hangs over the banks, it will prevent a recovery in the credit markets."
The structured finance market has also expressed interest in the Term Asset-Backed Securities Facility (TALF), which at press time was said to be readying to purchase up to $200 billion 'AAA' ABS securities, including auto, student loans, credit cards, and small business ABS. Although there has been no news yet, final regulations due before implementing TALF are expected to be issued in early February. "The market is still waiting for the program to fire up," according to Gainor, who said market participants are hopeful that the government will do its first financing this month.
Reports have also suggested that the U.S. Department of the Treasury is committing up to $60 billion for student loans by using the Federal Financing Bank to backstop a conduit put together by Citigroup and Morgan Stanley. The conduit will issue ABCP to finance the purchase of existing and new student loans from banks.
Holders of ABS securities are also closely watching modification initiatives.
Market participants agreed that it is highly likely legislation will be passed allowing for modifications of the terms of mortgage loans by bankruptcy courts. But, as the legislation is currently proposed, this change should only affect existing ABS, and not the new issuance when the market comes back, Gainor said.
More recently, there has been talk of a program similar to FDIC Chairman Sheila Bair's, which would have the government use money from TARP to guarantee modified mortgages.
With the array of initiatives, a common thread is the administration's focus on the financial system. "The good news is that there is continued emphasis by President Obama to address the financial system itself," said Mark Fleming, chief economist at First American Corelogic. Furthermore, the markets have been separated into buckets that individually focus on liquidity and the ability of the banks to survive, the housing market and homeowners, and economic issues, he said.
However, there still remain other variables regarding a recovery in the structured finance market, including the ability of investors to do their own credit analysis. These same investors will also need to regain confidence, Fleming said. What the new regulatory structure will look like, or is intended to look like, will also remain a wild card, he said.
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