Tuesday, March 3, 2009

TALF To The Rescue?

The Federal Reserve is expected to announce details of its Term Asset-Backed Securities Loan Facility (TALF) today, a facility that will fund up to $1 trillion of non-recourse loans to investors who purchase AAA-rated asset-backed securities. The program could represent a turning point for the economy and the financial markets by jump-starting lending in critical areas of the economy and by reviving the asset-backed securities market, where issuance has fallen to a crawl, from a pace of about $1.5 trillion to $2.0 trillion in 2005 to 2007. The program is designed to revive lending for automobile loans and leases, credit card loans, student loans and small business loans guaranteed by the Small Business Administration. If it works, a swath of economic data will be impacted, probably by the end of the second quarter or early in the third quarter, altering perceptions about the economy and boosting household, business and investor sentiment.

It is easy to understand how the TALF could turn the tide in the financial and economic crisis. Picture this: as a result of the TALF, car sales stabilize. In turn, the factory-laden economic calendar begins to cast off a new message and a plethora of data show signs of reaching a trough: durable goods orders, factory orders, industrial production, the Philadelphia Fed survey, the Chicago index, the New York Empire survey, the ISM index and retail sales. Indications of a bottom then begin to dominate the news flow, affecting sentiment. The process eventually feeds on itself. Confidence in this outcome increases when one considers the massive fiscal stimulus program that will begin hitting the tape in the second quarter.

Key, then, will be to look each Thursday at the Fed's balance sheet and see whether the Fed has lent any money via the TALF. The more it does so, the more that it would begin to make sense to move one layer out of the risk spectrum. For a few months, I have focused on the likelihood of outperformance in agency and agency-mortgage-backed securities (MBS) as well as corporate bonds in response to the Fed's Nov. 25 announcement of its plan to purchase up to $100 billion agencies and $500 billion agency-MBS, but any meaningful expansion of the TALF would justify consideration of corporate equities as well as forays into emerging markets, chiefly the mainstays of those markets, Brazil and China in particular.

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