What it means
Many lenders do not hold the loans they make. They bundle car loans, credit card balances, student loans and small business loans into securities, sell them to investors and use the money to lend again.
These securities are called asset-backed securities, and the market for them depends on investors being willing to buy. In late 2008 that market froze, so lenders could not raise money to make new loans.
The Federal Reserve responded with TALF, offering investors loans to buy newly issued, highly rated asset-backed securities. The securities themselves were pledged as collateral (assets handed to a lender as security for a loan).
A key feature was that the loans were non-recourse. If the investor failed to repay, the Federal Reserve could keep the collateral but could not pursue the investor for more.
The government treasury also provided a layer of protection against losses, which made the structure safe enough for the central bank. The loans were also over-collateralised through a haircut, meaning the loan was less than the value of the collateral.
A haircut of 10% means the investor borrows 90% of the collateral value and puts up the rest from its own funds. This gave the investor a stake in the outcome and protected the lender.
For a business, the programme matters because it shows how central bank action can reopen a stalled funding market. Companies that rely on asset-backed funding, such as lenders to car buyers, saw borrowing costs come down as investors returned to the market.
The lesson is that access to funding can fail for reasons unrelated to the quality of a borrower. There is also a cost-benefit question for the public.
The central bank earned interest on its loans and the structure was designed so that losses would be unlikely, but the risk was real and was taken on behalf of taxpayers. Supporters argue that the benefit of a working credit market outweighs that risk, while critics worry about the central bank taking on credit exposure at all.
In practice
Real-world examples.
Example
A finance company that lends to car buyers cannot sell its loan bundles because investors have left the market. After TALF opens, an investment fund borrows to buy the securities and the finance company raises fresh funds. It uses the money to approve new car loans.
Example
A student loan provider wants to refinance a pool of loans but finds that buyers demand very high yields. With TALF financing available, investors accept lower yields. The provider's cost of funding falls and it passes part of the saving to borrowers.
Example
A small business lender backed by government-guaranteed loans bundles them into securities. An investor uses a TALF loan to buy them, which brings in cash for the lender. The lender then makes new loans to local firms that would otherwise be turned down.
Formula
Calculation
TALF loan = value of collateral x (1 - haircut)
Investor's own funds = value of collateral - TALF loan
An investor wants to buy $50,000,000 of highly rated auto-loan securities. The haircut is 10%, so the loan is 50,000,000 x (1 - 0.10) = 50,000,000 x 0.90 = $45,000,000. The investor must provide the remaining 50,000,000 - 45,000,000 = $5,000,000 of its own money. Because the loan is non-recourse, the most the investor can lose is that $5,000,000, and the lender's protection is the collateral worth $50,000,000.Case study
Seen in the real world.
Greenfield Auto Credit is an illustrative, fictional lender that makes $200,000,000 of car loans each quarter and relies on selling bundled loans to fund new lending. When investors stopped buying, its funding costs doubled and it cut its lending by half.
After a central bank facility similar to TALF opened, investors returned to the market, because they could borrow against the securities at a modest cost. Greenfield issued a $300,000,000 bundle and the securities sold at yields three percentage points lower than a few months earlier.
On that amount, the illustrative saving was about $9,000,000 a year in interest. Greenfield restored its lending to the earlier level, and the finance director noted that the saving came from market confidence returning, not from any change in the quality of its loans.
Watch out
Common mistakes.
- Thinking TALF lent money directly to consumers or small businesses, when it lent to investors who bought securities backed by those loans.
- Assuming the central bank carried all the risk, when the haircut meant investors had their own money at stake.
- Treating the programme as permanent, when it was created as an emergency measure for stressed markets.
Questions
People also ask.
What does TALF stand for?
It stands for the Term Asset-Backed Securities Loan Facility, a Federal Reserve lending programme.
Why was it created?
It was created to restart the market for asset-backed securities when it froze in the 2008 financial crisis, and a version was used again in 2020.
What does non-recourse mean?
It means the lender can claim the collateral if the loan is not repaid, but cannot ask the borrower for additional money.
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