William C Dudley: A preliminary assessment of the TALF Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the Securities Industry and Financial Markets Association and Pension Real Estate Association's Public-Private Investment Program Summit, New York, 4 June 2009. *  *  *  I thank you for this opportunity to speak to you today about what we at the Federal Reserve have been doing to improve market function and credit market access. Since August of 2007, the Fed has introduced a wide range of special facilities designed to improve market functioning, increase the availability of credit and bring down borrowing costs for households and businesses. Today, I am going to focus my comments on the Term Asset-Backed Securities Loan Facility (TALF), which in my view is one of our most innovative programs. This facility is a complement to the Public-Private Investment Program efforts being undertaken by the Federal Deposit Insurance Corporation and the Treasury, which are the primary focus of today’s conference. In what follows, I would remind you that my comments reflect my own views and opinions and not necessarily those of the Federal Open Market Committee or the Federal Reserve System. I will discuss how the securitization markets broke down last fall creating the need for TALF, how the TALF works and what it already has accomplished, where we see it evolving going forward, and finally, some preliminary thoughts on the future of securitization markets.
TALF loans are leveraged – haircuts against the AAA-rated collateral average about 10%; the loan terms are three or five years; and the loans are non-recourse, which means that if the economy performs very badly and the securities fall sharply in value, an investor can put the collateral that secures its TALF loan back to the Fed, only losing the collateral haircut. The loan is then extinguished. Because term, non-recourse financing is not readily available from the private sector currently and the spreads on asset-backed securities remain elevated, TALF provides an opportunity for investors to purchase AAA-rated consumer asset-backed securities and earn relatively high returns. Although some observers are concerned by the prospect of TALF investors achieving relatively high returns, I think that concern is misplaced. Investor participation is absolutely essential in order for the TALF to improve the availability of credit and to bring down the cost of credit for households and business. The prospect of relatively high expected risk-adjusted returns is precisely what gives investors an incentive to participate in the program. As investors begin to take advantage of the attractive TALF terms, spreads on ABS securities contracts, and rates of return go down, and most importantly, the costs of funds for the issuers of the underlying securities falls. Investors’ actions to seek attractive returns lead to lower borrowing costs for households and businesses. Does the possibility of attractive returns for TALF investors mean that the Federal Reserve is taking on large credit risks?