Creditflux Newsletter

In Greek mythology, Atlas was a Titan who fought on the losing side and was thus condemned by Zeus, the victor, to support the heavens on his shoulders. In a similarly heroic but less celestial manner, the Federal Reserve launched Talf (the Term Asset-Backed Securities Loan Facility) to prop up securitisation and prevent it from crashing. While Talf has succeeded in injecting some demand in the new issuance market for consumer ABS, the Fed has not yet offered an exit strategy. Until it does, systemic risk remains a concern for structured finance and the budding economic recovery is at risk.

Before the summer of 2007, the securitisation market, not just RMBS but consumer ABS, such as autos, student loans, equipment leasing and credit cards, experienced phenomenal growth in volume. This expansion was made possible in part by a large and increasing number of investors with insatiable appetites for the large tranches of triple A-rated ABS paper. Such investors included monolines, high grade ABS CDOs, ABCP conduits and SIVs. The growing ABCP market fed this development as money market funds, corporate treasuries and mutual funds wanted more short-term, highly rated paper backed by ABS.

During the bull market, it was not uncommon for bankers to take a buy order from a SIV for a few hundred million of a triple-A ABS. The SIV would then turn around and do a take-down from its ABCP facility to finance the trade. But when the subprime mortgage market crashed, some commercial paper with the highest ratings suffered defaults and losses, thereby making it unlikely that SIVs would return.

To support the securitisation market, the Fed itself became a SIV. It did this by establishing Talf, a lending programme whereby investors can apply for non-recourse loans secured by eligible collateral that includes US dollar-denominated triple A-rated cash consumer ABS.

So the Fed is investing in debt backed by long-term assets, and funds itself short-term by issuing currency and deposits. Just like a SIV, it borrows short, buys long and buys big.

Since Talf’s launch in March of this year, ABS securities issuance has jumped to a respectable figure of $80 billion for the past six months, compared to $13 billion in the first quarter. Reuters reported that investors requested upwards of $41 billion of loans under Talf to purchase $67 billion of ABS issued since March.

Instead of the monolines, conduits and SIVs, Talf is the Atlas holding up the sky. But what will replace it when the facility expires next year? Who will be the new taker of senior securitised risk?

Do not look to the banks for a solution. Banks exited the consumer lending business because of the success of the securitisation market and are not likely to re-enter it any time soon. Banks would rather deploy their precious capital in products with higher margin.

Finding the answer to this trillion dollar question is crucial if the fragile recovery in the American economy is to be sustained. At stake is the ability of car buyers to get a loan and students to afford higher education. While the popular press carries headlines about risk appetites returning to the markets generally, it is questionable whether new issuance ABS would continue at its current pace if Talf was to terminate tomorrow.

Consumer ABS provides the cheap and massive financing that is needed to restart the consumer oriented US economy, so the ABS market must not be jeopardised. The world needs a new Atlas.

Jack Chen, a New York-based structured finance, CDO and derivatives professional, writes in a personal capacity.