The market for these securities had dried up because the traditional investors in these securities – SIVs, bank-related conduits and securities lenders – have either disappeared or are balance sheet constrained. This has reduced the availability of credit for consumers and led to higher borrowing costs. The first subscriptions for financing under TALF Version 1.0 will occur on March 17. The first batch of new securitizations will be funded on March 25. TALF Version 2.0 will follow. This will broaden the TALF into new asset classes such as Commercial Mortgage Backed Securities. Development of this phase is still in its early days. But it anticipated that the size and scope of TALF will expand sharply in the months ahead. So how will the TALF restart securitization activity and provide balance sheet capacity to the private sector? By providing leverage and 3-year term, non-recourse financing to investors, the TALF should increase the demand for AAA-rated securitizations. Yields of LIBOR + 400  4  BIS Review 28/2009  basis points may not be sufficiently attractive on an unleveraged basis, but at 10 times leverage the returns become very attractive. The non-recourse nature of the loans is also important. If the price of the security falls considerably, the investor just loses an amount equal to size of the haircut.
The FDIC has also guaranteed bank  BIS Review 28/2009  3  and bank holding company funding through its Temporary Guarantee Liquidity Program. As a result, bank term funding spreads have narrowed a bit this quarter. However, while the Federal Reserve can provide liquidity to the banks and dealers and the FDIC can reduce counterparty concerns via its guarantee program, these steps cannot force banks and dealers to on lend these funds to their customers. This is where several new initiatives may show the way forward. First, the Federal Reserve has begun to bypass the banks and dealers, which are balance sheet constrained, and instead has begun to provide liquidity directly to borrowers. One of these programs, the Commercial Paper Funding Facility or CPFF has been up and running since late October. Under the terms of the CPFF, the Federal Reserve offered to purchase A1-P1 rated commercial paper at 84-day maturity from issuers. Although A1-P1 rated paper is the highest quality stuff, it makes up almost all of the CP market. The only catch is that the CPFF will only buy at rates that are quite high compared to the rates one would expect in the market during normal times. The Fed has to charge a high rate and up-front fees to provide some equity in the fund to offset potential credit losses. This facility has worked extremely well in restoring market function in the commercial paper market. Initially, there was a surge of issuance into the facility.