TALF Ready to Go

Nissan became one of the first firms to utilize the Fed-Treasury TALF program today, selling $1.3 billion in automobile debt to the facility. Today is the official start of this new, experimental public-private initiative.

TALF, which attempts to restart the market for ABS, allows banks and corporate finance divisions to sell NEW assets to TALF -- essentially a new market sponsored by the government. To encourage buying of these assets, TALF will provide loans to hedge funds and private equity groups to purchase the assets. Using public money, the government is hoping to restart this "frozen" market, allowing private funds to engage in transactions without putting up much of their own money.

The portion that private equity and hedge funds will be contributing is determined by a haircut term specified by the government (see below). A haircut is a discount applied to the value of an asset; in this case, a haircut specifies the maximum amount the government will lend out. For example, a $100 security with a 10% haircut would require a private investor to provide $10 to the transaction, with $90 being picked up by the government.

However, some experts think a predetermined haircut would force the government to become too overexposed to the cost of funding the purchase of such assets. Instead, a bidding system that lets private money determine the amount they are willing to fund would allow the government to calculate the appropriate haircut percentage. The article I linked illustrates this system using the following scenario:

For example, Bidder A is willing to fund $10 billion with 50% coming from government credit, and Bidder B is willing to fund $10 billion with 60% coming from government credit, and so on. When the government receives all bids, it can determine the right level of government credit, say 70%, that’s necessary to get to the $100 billion.

There are certainly strong arguments for a bidding system like this; however, I believe the current term sheet by the government is essential for the early stages of TALF's $200 billion appropriation. As more lending is approved (upwards of $1 trillion), and credit spreads between triple-A ABS and Treasuries begin to fall, the thawing of these particular securitization markets may provide the government with an opportunity to increase haircut terms or introduce some form of a bidding system.