Jump-Starting Securitization

Reviving the structured-finance market may do more to get credit flowing than fixing the banks

By Jane Sasseen and Matthew Goldstein

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If there is a supreme irony in this financial crisis, it may be this: The complex money games that helped sink the U.S. economy are actually crucial to any sustainable recovery.

In March the Federal Reserve kicked off a $1 trillion campaign to resuscitate the securitization, or structured-finance, markets. This is where Wall Street firms pool and repackage all manner of cash-flow-producing financial assets—from mortgages to credit cards—into securities, which are then sold to investors. During the boom, Wall Street stretched to dangerous extremes the system of bundling mortgages and other loans into bonds for investors. The securities are still blowing up and damaging the economy.

While a lot of attention has rightly focused on the health of the U.S. banking system and its ability to lend, reviving the securitization market is probably even more important at this stage of the game. Bank lending is actually on the rise—if at a much slower pace than in the past. The securitization market, which once accounted for a third of lending in the U.S., is all but dead. Banks and other financial firms sold $152 billion in asset-backed securities last year, down from a high of $906 billion in 2006, according to trade publication Asset-Backed Alert. So far this year, only $16 billion of deals have been done. "The closing of securitization markets has added considerably to the stress in credit markets and financial institutions generally," Fed Chairman Ben Bernanke said in an Apr. 3 speech. The new plan "is aimed at restoring securitization."

No Cold Turkey

Success is far from assured. But if the Fed can fine-tune the details of its current program, the plan might just help thaw the credit markets, the lifeblood of the economy. The government needs to lure investors back into the market, pumping more money into the system. "The government can't let the economy go cold turkey on the securitization market," says Frederick Cannon, the chief equity strategist at investment bank Keefe, Bruyette & Woods (KBW).

The federal efforts to revive this critical market center on the inelegantly named Term Asset-Backed Securities Loan Facility, or TALF. Uncle Sam has promised to lend up to $1 trillion to private investors to buy newly issued securities. The Fed also intends to let investors purchase existing securities to help create a market for these moribund bonds—an expansion that could happen this summer.

So far, the impact has been minimal. Credit spreads have narrowed somewhat, a sign that the debt markets are improving. But the interest of hedge funds, private equity, and other big firms has been waning. Investors applied for only $1.7 billion in TALF funds in the second round of financing that closed on Apr. 7, a quarter of the amount in the previous round.