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Busch: Danger Of Short Term Solutions Becoming Long Term

Today, we have new developments in the US government's attempts to restart the credit markets after the nuclear explosion that occurred in September. Clearly, the economy continues to reel from the extraction of low interest rates and available credit to financial institutions, to businesses, and to consumers.

For the first time since 1993, credit card companies did not have any takers for asset backed bonds last month. From mid-September to mid-October, commercial paper issuance dropped by 25%. Over the last 4 weeks, leverage loan issuance has been a paltry $2.0 billion. High yield issuance since the beginning of November has been zero. The credit picture has been bleak.

Fortunately, the US government continues to adjust. The Federal Reserve's commercial paper program started at the end of October and has had 4 weeks of growth. Clearly when the government backs up a segment of the credit markets, this stabilizes the segment and provides comfort for investors to own the paper. This success has generated two additional moves.

Today, the Federal Reserve announced a $600 billion program to buy mortgage-related debt and securities and a $200 billion facility to buy consumer debt securities according to Reuters. The U.S. central bank said it would buy up to $100 billion in debt issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, the government-sponsored mortgage finance enterprises. The Fed also said it would buy up to $500 billion in mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae. The GSE purchases are aimed at supporting the housing markets by reducing funding costs for them and thereby reducing mortgage rates.

    • Fed Unveils Plan to Support Mortgages, Consumer Credit

The consumer facility is intended to improve lending in these markets by supporting issuance on a non-recourse basis to holders of AAA-rated asset backed securities. This is a more complicated program that will involve setting up a special purpose vehicle (SPV) to finance asset purchases. Under the Term Asset-Backed Securities Loan Facility, or TALF, the Fed announced that it will extend up to $200 billion in nonrecourse loans to holders of asset-backed securities backed by consumer and small business loans according to the WSJ. "The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads," the Fed said.

Along these lines, the FDIC's Temporary Liquidity Guarantee program or TLGP is beginning to facilitate bond issuance by financial institutions. Yesterday, Goldman Sachs Group Inc. received strong interest from investors for $2-3 billion in bonds issued under the TLGP. Firms can borrow under the program and receive a backing/guarantee by the FDIC for a fee. The firms have to issue debt over the next six months that matures by June 30th, 2012. The bond offering is expected to be completed today. The Journal estimates that the three year Goldman bonds are likely to yield about two percentage points more than three-year Treasury bonds, or around 3.5% which is a hefty discount from Goldman's outstanding debt that trades at yields of 7% or higher. Other firms are expected to follow with debt offerings.

Overall, it looks like the US government has taken over the bond insurance industry and filling the void left by monolines. Unless a piece of debt is tied to the backing of the US government or guaranteed by it, there will either be significantly higher interest rates or no interest by investors or both. The danger for the programs is that they morph from being positive short term solutions to dangerous long term support programs. For now, they are critical for the credit markets and appear to be working.

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Andrew Busch

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