Private investors reviewing terms for government credit-revival plan

Washington Post

WASHINGTON — The government’s signature effort to revive the consumer credit markets is expected to start slowly as private investors involved in the initiative are struggling to ensure its terms are workable, industry and federal officials said.

To give hedge funds and other investment firms more time, the Federal Reserve Bank of New York on Friday pushed back the deadline for participating in the program by two days, to Thursday.

Officials are counting on these wealthy private investors to borrow money from the government and use it to buy recently issued, highly rated securities that finance much of the nation’s debt, such as auto loans, student loans and credit cards. The government hopes this activity will thaw the market for such “asset-backed securities” and free lenders to make more loans.

A number of prominent investors, from large hedge funds to major banks, have expressed interest in buying the securities, largely because the terms of the government financing would give them a windfall profit if the credit markets recover and limit their losses if the markets do not. Two banking giants, J.P. Morgan Chase and Barclay’s, are setting up a special investment fund to draw pension funds into the program.

But other investors are more skeptical, saying they will wait on the sidelines to see how the program will work in practice. Meanwhile, several major hedge funds said it has proven complicated to draft contracts that would set the terms of participation and protect the firms against fraud and other hazards.

Officials overseeing the program said they do not expect investors to borrow the full $200 billion in loans being made available by the Fed this month. The Treasury and the Federal Reserve have said that the initiative could eventually grow to $1 trillion.

Much is riding on the success of the program, known as the Term Asset-Backed Securities Loan Facility, or TALF. It exceeds the size of every other federal effort to address the crisis so far and offers a model for future federal efforts to aid the credit markets.

The government is adopting a similar approach for a separate initiative, which also relies on an alliance between the government and affluent investors, to buy toxic assets that have soured during the two-year financial crisis. Treasury officials may detail this program, called the public-private investment fund, as soon as this week, sources said.

Investors interested in buying asset-backed securities through the TALF must submit their applications by Thursday. Over the next six days, investors would be able to bid in electronic auctions to buy securities backing loans from student lenders, auto finance companies, and specialty lenders for small businesses and credit card companies. The auctions will managed by the New York Fed. On March 25, the Fed will offer loans to the winners of the auction.

A wide range of lenders, especially those that provide financing for car buyers, are interested in selling off these securities, including Ford Motor Credit, CarMax and auto lender World Omni, among others, sources familiar with the matter said.

In a typical TALF deal, a hedge fund would use $1 million of its own money and get a $9 million loan from the Fed, payable after three years, to buy a $10 million asset-backed security. Hoping that the market for these assets recovers, the hedge fund would hold the asset for three years.

If the security rises in value to $11 million, the investor would keep the profit, essentially doubling the initial investment. The government, meanwhile, would consider the deal a success because consumer lending was spurred.

If the value fell below $9 million, the hedge fund would lose its down payment but nothing more.