The government has been launching stimulus programs, financial entities and other programs designed to lead us out of recession nearly as fast as lawmakers and bureaucrats can come up with acronyms. As soon as the media begins to tout a new one, there's another on its heels. (For a comprehensive review of the current crisis, refer to The 2007-2008 Financial Crisis In Review.)
From TAF to PPPIP
It all began in December of 2007, when the United States Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank (ECB) and the Swiss National Bank took coordinated action to address the developing credit crisis. More than two years later, the bailout efforts continue. The primary flavors of the alphabet soup in the United States include:
The Term Auction Facility was launched on December 12, 2007. It permitted banks to use securities as collateral to take short-term loans from the federal government for periods of either 28 or 84 days. In the Fed's words, TAF is a "credit facility that allows a depository institution to place a bid for an advance from its local Federal Reserve Bank at an interest rate that is determined as the result of an auction." The first auction took place on December 17.
The Term Securities Lending Facility was launched on March 11, 2008. Like TAF, which made credit available to "depository institutions," TSFL made $200 billion in credit available to other financial institutions (brokerage firms and other entities such as Fannie Mae, Freddie Mac, Citigroup, Countrywide Financial) for 28-day periods as opposed to the traditional overnight loans. These entities use securities as collateral to borrow money. Weekly auctions began on March 27, 2008.
On March 17, 2008, the Federal Reserve announced the creation of the Primary Dealer Credit Facility. Unlike TAF and TSLF, which were designed to address long-term funding needs, PDCF provides daily access to cash to the same entities that borrow from TAF and TSLF. The institutions pay an interest rate equal to the Fed's primary credit rate for short-term (overnight) loans. (Learn more in Top 6 U.S. Government Financial Bailouts.)
In September, 2008, the Federal Reserve Board announced the creation of the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility, which loans money to banks and bank holding companies to help them meet redemptions in money market funds. They do this by lending funds to borrowers to purchase eligible ABCP's from the money market fund. Because the market for commercial paper dried up, the government feared that investors would be unable to redeem their assets from money-market funds. This could have been a major financial meltdown, as money-market funds have been touted as cash-like, safe investments.
While previous programs were designed to thaw the frozen credit markets, the serious attempts at economic salvation really started with the Troubled Assets Relief Program. TARP, also known as "the bailout," entered the world on October 3, 2008. It was $700 billion program conceived in response to financial institutions struggling under the weight of sub-prime loan defaults. The greed-driven lenders gave money to foolish borrowers that were obviously unable to repay it, so the government agreed to use tax-payer money to take the bad loans off of the lenders books in order to thaw the credit markets. (Learn more about the meltdown in The Fall Of The Market In The Fall Of 2008.)
TALF came next. In March of 2009, the Term Asset-Backed Securities Lending Facility, or bailout number two, tossed $200 billion more into the bailout pool by printing new money. The government launched TALF after the asset-backed securities (ABS) market froze over in October, causing consumers and small business owners to be unable to access credit.TALF was supposed to "help market participants meet the credit needs of households and small businesses by supporting the issuance of ABS collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA)." This effort also wasn't enough.
Bailout number three, the Financial Stabilization Plan, grew TALF to a trillion dollars. It also permits commercial-mortgage backed securities (CMBS) to be used as collateral.
The Commercial Paper Funding Facility came along in October of 2008, as commercial paper fell victim to illiquid credit markets. It was designed to provide a market for commercial paper by purchasing commercial paper from eligible issuers. The facility would use a special purpose vehicle (SPV) to buy and hold these commercial paper to maturity and use the proceeds at maturity to repay the funds they borrowed from the Fed.
The Public-Private Investment Program, rolled out in March 2009, was created to buy bad assets in order to get them off of banks' books. It was funded with a combination of TARP money and money from private investors. The program's main purpose was to provide price discovery in the market for toxic assets and to remove these assets from the balance sheets of financial institutions.
The long, complicated saga can be summarized as the result of a consumption-crazed society willing to borrow more than it can afford to repay from lenders that were all too willing to dole out the cash in the name of ever-increasing profits. After the loans were made, they were packed into structured products and sold to investors who didn't understand what they were buying and didn't want to as long as the investments generated hefty returns. When the borrowers failed to repay the loans, the fancy investments fell apart, leaving the taxpayers to fund the cleanup. (Find out more in Who Is To Blame For The Subprime Crisis? and Collateralized Debt Obligations: From Boon To Burden.)
The increasingly complex array of structured products form an alphabet soup of their own:
- mortgage-backed securities (MBS)
- collateralized mortgage-backed obligations (CMBO)
- collateralized debt obligation (CDO)
- collateralized bond obligation (CBO)
- collateralized loan obligation (CLO)
While the alphabet soup of investments and programs designed to clean up after them is a deep and messy brew, the lessons from the debacle are far clearer and apply to lenders, borrowers, businesses and individuals alike, include those that created the mess and those that got caught up in it. First, don't lend or borrow more that you can afford to repay, and second, don't buy or sell anything that you don't understand. (For more on what caused the credit crisis, read The Fuel That Fed The Subprime Meltdown.)