- The Washington Times - Monday, February 9, 2009

Banks have become the only game in town for most businesses and consumers looking for loans, and that’s why the government is gearing up for what could be the most expensive bank bailout ever.

Entire trillion-dollar markets for securitized loans have frozen or collapsed in the past 18 months, including parts of the corporate debt market known as commercial paper, private mortgages, auto loans, student loans and credit cards. The result: Banks are often the only lenders still able to satisfy critical credit needs.

“We’ve wiped out the investment banking system. We’ve frozen the commercial paper markets, and virtually all the asset-backed markets … are virtually out of existence or frozen,” said Martin Regalia, chief economist at the U.S. Chamber of Commerce. “So banks are once again the only game in town.”

Treasury Secretary Timothy Geithner is scheduled to present the administration’s plan for shoring up banks further Tuesday, using a combination of capital infusions, government guarantees and outright purchases of souring loans through a “bad bank” to help major banks deal with accumulating losses on their loan portfolios.

Before last fall’s financial crisis, banks provided only $8 trillion of the roughly $25 trillion in loans outstanding in the United States, while traditional bond markets provided another $7 trillion, according to the Federal Reserve. The largest share of the borrowed funds - $10 trillion - came from securitized loan markets that barely existed two decades ago.

People seeking to buy homes and refinance mortgages since the fall of 2007 have found loans harder to obtain because of the collapse of nearly all but the conventional market for 30-year loans.

Students bound for college started finding financing more difficult a year ago as the market for securitized student loans dried up, while car buyers, small businesses and credit card customers all have seen their usual credit sources evaporate more recently.

Perhaps the most acute shortage of credit is being felt by businesses, which before September got less than a third of their loans from banks. Most businesses preferred to take advantage of the better interest rates and terms offered in securities markets, where they could tap into cheap funding from abroad. For short-term loans of one to six months, businesses went to the commercial paper market, while they secured funding for long-term projects and investments in the corporate bond market.

But the bond market for months has been largely closed or prohibitively expensive to all but businesses with top credit ratings. Portions of the commercial paper market have entirely shut down and may not come back. Moreover, some of the major investment banks that used to underwrite and market those loans have gone out of business.

“It’s hard for banks to suddenly take up all this other slack, because it requires a certain expertise to make good loans and service those loans,” said Mr. Regalia. “They don’t have the back office at this point.”

Many legislators in Congress complain that banks aren’t lending, and cite that as an excuse to vote against further bank bailout funds. Their constituents are angry that banks seemingly are not meeting their needs despite massive cash infusions from the Treasury Department. But Mr. Regalia said these critics are wrong.

“Banks are lending more, but 70 percent of the system isn’t there anymore,” he said. “They’re doing their jobs. They’re being careful. But at the same time, the rest of the system has so collapsed that we’re still woefully short of credit.”

The Federal Reserve since September has stepped into the void to try to revive collapsed securities markets, starting with the commercial paper market. The Fed, using its own resources and seed money from the $700 billion Treasury bailout program, for several months has been buying top-rated three-month commercial paper. Under a similar program, this month it will start purchasing securities backed by student loans, auto loans, credit cards and small-business loans.

Fed Chairman Ben S. Bernanke noted recently that the Fed’s commercial paper program is having modest success at reviving that market. The Fed’s presence as a buyer in the market seems to have assuaged worries that companies won’t be able to roll over their debt when their paper comes due. He said he hopes the program to revive the securities market for consumer and small-business loans will work the same way.

“If the program works as planned, it should lead to lower rates and greater availability of consumer and small-business credit. Over time, by increasing market liquidity and stimulating market activity, this facility should also help to revive private lending,” he said.

The Fed hopes that private lenders eventually will come back into the moribund markets, enabling the central bank to make an exit.

In light of the severe freeze in securities markets, Mr. Bernanke has repeatedly urged lawmakers to stay focused on shoring up banks. He warned that without a strong banking system and functioning markets, the economy will be unable to recover from a deep recession even if Congress passes a massive stimulus program.

Congress’ demand that banks fill in for collapsed securities markets poses a dilemma for the banks, not only because most do not have the capacity to ramp up to such large-scale lending quickly.

The securitized loan markets provided an essential part of the machinery that enabled banks to lend in the first place. By selling most of their portfolios of mortgages, business and consumer loans to investors, banks in the past freed up money to make new loans. That machinery is now stalled and no longer able to assist banks that want to lend.

“Now that the securitization markets have dried up, what the government is asking the banks to do is like asking a hospital that delivers a newborn baby to raise him until he’s 18 years old,” said Nicole Gelinas, an analyst at the Manhattan Institute. “Banks simply don’t remember how to be banks - that is, long-term direct lenders to customers - anymore, since the securitization markets have done that job for so long.”

While the Fed and Treasury are scrambling to try to piece back together broken markets, some credit analysts say that’s like trying to put Humpty Dumpty back together again, and warn that some of the securitized loan markets may never return.

Former Fed Chairman Alan Greenspan mourned the death of the subprime mortgage market, which, for all its abuses and problems, had enabled a generation of low-income renters to pursue homeownership for the first time. The market for pooled subprime loans, known as collateralized debt obligations (CDOs), collapsed at the end of 2007 and, by most accounts, will never come back.

Because of the surging defaults on subprime and other exotic mortgages, investors have shied away from buying the loans, forcing banks and Wall Street firms to hold them on their books and take the losses. Furthermore, the taint that the mortgage crisis gave to especially complex securitized loans like subprime CDOs has made it difficult to sell other loans that were structured like them, often by the same Wall Street firms that created the mortgage securities.

Some foreign investors that gobbled up such debt instruments when the economy and housing market were booming now exhibit a disdain for the securities.

Foreign investors from China to the Persian Gulf started boycotting U.S. corporate bonds of all kinds last summer, even widely held mortgage securities issued by Fannie Mae and Freddie Mac. Countries like Russia, struck by their own economic crises, started selling off substantial amounts of their holdings.

Russian Prime Minister Vladimir Putin and top Chinese officials recently have asserted their belief, shared by many overseas investors, that unregulated Wall Street firms caused the global financial crisis. Wall Street wizards invented securities that were so risky and hard to understand that they even destroyed the banks that created them, including Bear Stearns and Lehman Brothers.

Whether Wall Street will ever again be able to pool loans and securitize them in forms that the rest of the world will buy remains to be seen. But the Fed and many economists say at least a partial revival of the moribund markets will be essential for an economic recovery in the United States, which for years has been dependent on such credit for growth.

Louise Purtle, an analyst with CreditSights, said the securitized loan markets will have to stage a comeback in one form or another, because banks will never be able to replace the massive amount of credit they provided. “The implosion of the shadow finance system left a gaping whole in the credit creation process that traditional banks would find hard to plug even from a state of relative health, let along from their loss-crippled current status,” she said.

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