The TALF bailout is coming online, and Fortune takes a good look at exactly how it works for the big investors who will be involved. It works very, very well for them.
So well that William D. Cohan gets people dropping adjectives like “shockingly” tilted toward investors and “irresponsible” to describe how the government has set up the program for their benefit. And those words come from Wall Street types themselves.
Fortune’s lede explains the TALF program about as well as any I’ve seen:
Imagine if you were not really in the market for a house but the government came along and said that it would finance 94% of a home’s purchase price with a mortgage rate of less than 3%. Still not interested? Wait, Uncle Sam has some additional sweeteners: if you do the deal and buy the house for only 6% down, you also get the equivalent of rental income every month to the tune of at least an annualized yield of 10% of the purchase price.
But wait there’s still more: if, say, after two years, you decide you don’t want the house any longer, you can just walk away from it. No need to pay the balance of the mortgage (it won’t affect your credit rating), and you can keep the rental income received to date.
The big problem with this setup is obvious right? Cohan is smart to use the housing analogy here, because the TALF setup is creating a universe for investing strikingly similar to the one that created the housing bubble that set off the crisis in the first place. Only if anything, the TALF universe even more dangerously incentivizes speculation and overpaying. Unfortunately, that’s not made explicit in the piece. Readers are left to deduce that themselves.
But Fortune does use a couple of quotes to lead readers to that understanding:
“I’ve had accounts that dropped everything they were doing to take a look at this TALF financing,” one Wall Street trader explained. “It was like nothing they had ever seen. It beats any financing that the private sector could ever come up with. I almost want to say it is irresponsible.” For instance, Prudential Financial, Inc., the large insurer and investment manager, borrowed $786 million from the TALF as of March 31 and put up only $50 million to do so, some 6.4% of the deals.
That’s some major leverage.
Here’s another giveaway:
In addition, the TALF loan is not marked-to-market so if the underlying collateral deteriorates in value, the investor is not required to put up more equity. What’s more as the car payments or credit-card payments on the underlying security are made, the payments are distributed to the government and the investor on equal footing — that means the investor starts getting paid back at the same time as the government even though the government is the senior secured creditor and even though an investor has put up only a small fraction of the original money. One private equity investor, who would not normally have looked at investing in such a deal but did, called this particular aspect of the TALF “shockingly good.”
So the real problem here is that Treasury’s plan is essentially to reinflate the bubble to try to revive the securitization markets. Doesn’t seem like that’s likely to end well.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at email@example.com. Follow him on Twitter at @ryanchittum.