http://www.washingtonpost.com/wp-dyn/content/article/2009/03/05/AR2009030503762.html
U.S. to Invite The Wealthy To Invest in The Bailout
By David Cho
Washington Post Staff Writer
Friday, March 6, 2009; A01
The government is seeking to resuscitate the nation's crippled financial
system by forging an alliance with the very outfits that most benefited
from the bonanza preceding the collapse of the credit markets: hedge
funds and private-equity firms.
The initiative to revive the consumer lending business, outlined by
officials this week, offers these wealthy investors a new chance to make
sizable profits -- but, thanks to the government, without the risk of
massive losses.
The idea is to entice them to put their huge cash piles to work to
stimulate the financial system. They would be invited to buy up recently
issued, highly rated securities. These securities finance consumer
lending, such as credit cards and student and auto loans.
The program, which could involve the government lending nearly $1
trillion to these investors, exceeds the size of every other federal
effort to address the crisis so far. The initiative's approach could be
the model for future federal efforts to aid the credit markets, sources
familiar with government planning said. Officials call this strategy a
"public-private partnership," but in essence the government is offering
good deals to private investors to draw them into its rescue efforts.
Architects of this initiative have long been sensitive to the political
challenges of teaming up with hedge fund managers and private-equity
firms. But officials see these private investors as among the few who
have ample cash available. In public statements, officials have sought
to focus attention on the ultimate goal of freeing up credit for consumers.
The Treasury Department and Federal Reserve will continue to lean on
these private investors as officials expand their aid to more segments
of the lending markets each month, moving from consumer credit possibly
on to commercial mortgages and financial derivatives, the sources said.
But there is vigorous debate between the Treasury and the Fed and within
them over how the program should evolve and at what speed.
This approach will culminate in a separate program that aims to relieve
banks of toxic assets, backed by distressed loans, that are clogging the
firms' balance sheets, sources said. This second initiative, which
officials are hoping to unveil in the coming weeks, is also expected to
reach at least $1 trillion. It may create multiple investment funds,
financed by wealthy investors with matching dollars from the Treasury
and loans from the Fed, to buy toxic assets, sources said.
These two programs, focused on reviving consumer credit and clearing
troubled assets, each exceed the size of the other elements in the
financial rescue package being developed by Treasury Secretary Timothy
F. Geithner. These also include a $75 billion effort to aid homeowners
and an effort to inject capital into banks, which has already involved
hundreds of billions of dollars in public funds.
In the past, hedge funds and private-equity firms have not been major
buyers of the securities that provide financing for credit cards and
other consumer loans.
But the government is turning to these investors in part because
traditional buyers, such as retirement funds, mutual funds and
university endowments, have fled the markets. Many are deep in the red
and reeling from past forays into buying complicated debt securities.
Moreover, many pension funds have rules that ban them from borrowing
money to make investments, which is an essential ingredient in the
government's program. So many pension funds will not be able to participate.
Federal officials, however, have not given up on the traditional
investors and are considering setting up investment entities that would
allow pension funds to get a piece of the profits. Officials said
pension officials have expressed strong interest in this idea.
The consumer credit revival program, formally known as the Term
Asset-Backed Securities Loan Facility, or TALF, has been welcomed by a
range of hedge funds and private-equity firms as well as some lenders
who issue assets that finance consumer loans.
"Our members have significant interest," said Richard Baker, president
of the Managed Funds Association, the leading association for hedge
funds. "The plan recognizes that our industry can bring significant
resources to bear."
Here's how a typical TALF deal would work: A hedge fund uses $1 million
of its own money and gets a $9 million loan from the Fed, payable after
three years, to buy a $10 million asset-backed security, which finances
consumer loans. 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. The Treasury, using bailout funds approved by
Congress, would cover the next set of losses, with the Fed ultimately on
the hook for anything more.
Steven Schwartzman, chief executive of private-equity giant Blackstone,
said the program is "highly attractive" because of the government financing.
The TALF's primary aim is to get the "shadow banking system" running
again. A vast portion of the financing for loans issued in the United
States comes not from traditional banks but from other enterprises.
Some firms that issue consumer credit questioned the program's
limitations. Executives at one leading bank said restricting the program
to securities backed by only the highest-quality loans would be too
constraining.
For example, many loans taken out by auto dealerships to stock their
inventory do not have the highest ratings. Government officials, who
want to make sure dealers can get these loans, are considering expanding
the TALF to slightly lower-quality assets, sources said.
Some officials are concerned there may not be enough highly rated loans
that can be combined into securities to sell to investors.
Another matter of discussion among federal officials is whether to
lengthen the term of the financing extended by the government to
investors, sources said. With securities backed by auto loans, for
example, a relatively short period was deemed appropriate because these
loans mostly carry three-year terms. But when the TALF expands in the
coming months to aid other segments of the credit market, such as
commercial real estate loans, the Fed may have to lengthen the time
because such loans carry 10-year terms or longer.
If Fed and Treasury officials decide to extend the TALF model to the
purchase of toxic assets, this would require expanding the approach from
recently issued loans to those that are years old.
Each step away from the original target of the TALF -- recently issued,
highest-quality assets -- may force the government to protect itself,
which would involve offering less to private investors, officials said.
But if the government goes too far in shielding itself, it may fail to
generate interest by private investors. Striking the right balance --
among lenders who issue loans, investors who buy them and taxpayers who
are facilitating the transactions -- has been one of the greatest
challenges in developing the program, officials said.
Staff writers Neil Irwin and Binyamin Appelbaum contributed to this report.
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