We at the Fed are working through a number of highly complex issues to enable the creation of vehicles that will make it easier for a broader range of investors to have access to financing for ABS securities. The broader the investor base, the greater the demand for the securities, the lower the yield levels and the greater the improvement in credit availability. The rollout of TALF to the Commercial Mortgage Backed Securities market this summer will be important in determining the overall success of the program. The revival of the CMBS market is essential to stabilizing the commercial real estate market. As you know, commercial real estate values are under pressure for several reasons. Capitalization rates have climbed significantly, reducing commercial real estate valuations. In addition, the income generated from commercial property has diminished due to the contraction in overall economic activity. If the availability of funding for this market is not restored, the downturn in commercial real estate valuations and the losses for the holders of these assets will be greater. This will, in turn, likely further constrain credit availability. A revival of the CMBS market is also important to accommodate the demand for funds to refinance commercial mortgage loans that will be coming due over the next few years. If the CMBS market remains shut down, it is unclear where these funds will come from. After all, in recent years, the CMBS market has satisfied about 40% of the credit needs of the commercial mortgage sector.
This increase in yields did not solely reflect an increase in credit risk; it also reflected a genuine loss of confidence and an accompanying increase in risk aversion. Yield spreads on even the very safest ABS obligations soared hundreds of basis points. This can be seen in the fact that AAA-rated student loan tranches, with underlying loans 97% guaranteed by the federal government, climbed to yield levels as much as 400 basis points over LIBOR. With the spike in yields, the economic incentives to issue evaporated – issuance was just too costly and there was no active market. After averaging around $ billion per quarter of new originations in 2007 and the first three quarters of 2008, consumer ABS issuance plunged to only $ billion during the fourth quarter of 2008. Issuance of commercial mortgage backed securities ground to a complete halt and this market currently remains closed. So why did the ABS market collapse? There are many reasons. One factor was that in some areas, the risk management incentives of banks and other issuers of ABS were misaligned with those of the end investors in these securities. This misalignment manifested itself in the overall deterioration in lending standards that took place across the economy beginning during the middle part of this decade. Some originators did not do an adequate job of due diligence because the underlying loans were swiftly moved off their balance sheets through the securitization process.