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Did The Aig Bonus Backlash Kill Talf?

Matt Yglesias and Ezra Klein both have some good thoughts about why TALF is underperforming to this point. That's the program that's supposed to revive the markets for consumer, small business, and student lending by giving investors generous incentives to buy securities backed by those loans. The hope was to support up to a trillion dollars in lending through the program, but so far we're only talking about a tiny fraction of that amount--$4.7 billion in March, another $1.7 billion in April, according to The Washington Post. Matt and Ezra conclude that the big obstacle here is anxiety on the part of investors who, as Matt puts it, "are afraid that if they leap into this in a big way there may be a huge public backlash and then along come the executive pay restrictions and all the rest."

That seems like a big chunk of it, no question. And it doesn't shock me after the AIG bonus uproar in the House last month, which even the Senate seems to have been embarrassed by, judging from the way it basically ignored the House bill. It's also a reason why I can't fault the administration for trying to evade some of the restrictions that have repelled investors from TALF and similar programs.

Having said that, the problem seems to be as much the design of the program as the political risk per se. And I'd guess that's more fixable. Per the Post:

The Fed relies on primary dealers, or brokerage houses, to play a key role as intermediaries in TALF, funneling the government loans to investors and holding on to the asset-backed securities as collateral.

But the primary dealers have been extremely cautious in designing their contracts with investors, hobbling the program's progress, said people who have been involved with the deals. ...

The Fed loans, for instance, are supposed to be "non-recourse," meaning that the investors who participate cannot lose any more than they put at risk. But an executive of a primary dealer, who spoke on condition of anonymity because he was not authorized to speak publicly, said his firm and others are trying to structure contracts such that if a deal goes sour, they can go after all an investor's assets, not just those put at risk through TALF. ...

"The primary dealers are taking a very defensive posture, trying to protect themselves," said a government official involved with the program who also was not authorized to speak publicly. "Part of it is just generally being cautious, and part of it is because they're afraid if anything goes wrong there will be political consequences and reputational risk."

It sounds like it's not so much the investors who are discouraged by the political risks here as the primary dealers. The problem seems to be that, as intermediaries, the dealers don't have a chance at much upside, but face a big downside if the politics blow up on them. If there were a way for the government to lose the intermediaries, so that the only people facing political risk were the ones who stood to make big gains, I'd guess the program would be getting more traction. But maybe there's no practical way to do that.  

Relatedly, Matt makes a broader point about why the current dynamic is so dangerous:

This, it seems to me, is how you wind up with a Japanese-style banking sector and an L-shaped recession. The financial system, to be restored to health, needs hundreds of billions of dollars in additional funds. But not only is congress reluctant to appropriate such funds, the banks themselves no longer want to receive bailout funds because going on the government dole is bad for the parochial interests of bank managers. But would managers of insolvent institutions really prefer to see their bank sink than to accept a bailout that comes with the mere risk of congressional pay restrictions? Well, no, they wouldn’t. But they know, and investors know, that in a post-Lehman world the government isn’t going to let a big bank fail. And this implicit government guarantee is really the most valuable bailout of all. But it comes with no strings attached because the government can’t credibly threaten to withdraw it.

I agree that the dread L-shape is disconcertingly likely.

--Noam Scheiber