Thanksgiving surprise: $800 billion more for the credit markets

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The $800 billion in new outlays announced today by the federal government to unlock the credit markets might have come as a shockif you remembered Treasury Secretary Henry M. Paulson’s remarks a week ago as suggesting that he had no such new programs in mind for the rest of the Bush administration.

But what Paulson really said last week was that he didn’t intend to spend the second half of the $700 billion authorized under the Troubled Asset Relief Program, or TARP. And that’s still the case, because the $800 billion — which is going to buy or finance purchases of asset-backed securities — is coming not from the Treasury but from the Federal Reserve.

The Treasury is spending $20 billion of TARP money to provide “credit protection” to the Fed for some of its lending. But that appears to be an inside-the-beltway tactic that allows Paulson’s agency to share some of the risk of the deal.

Not that the government wants you to think it’s taking on much risk with these new programs.

Under the first one, the Fed is buying up to $600 billion in debt issued or guaranteed by Fannie Mae, Freddie Mac and other government-backed housing agencies.

These securities aren’t the “toxic” mortgage debt that TARP was originally designed to buy (but now won’t because most of the first $350 billion is being used to buy stock in banks).

But investors currently see Fannie and Freddie debt as much riskier than Treasury securities, even though the government has practically said it wouldn’t let Fannie and Freddie default. As a result, the securities are trading at unusually high yields relative to the yields on Treasuries. That means higher interest rates on mortgages -- exacerbating the housing downturn, the original cause of the credit crisis.

By buying Fannie and Freddie debt, the Fed believes the yields will go down, taking mortgage rates down with them. And if the market for that debt returns to normal, the Fed might even be able to sell the securities at a profit.

And that’s the simple initiative announced today.

The other one is called the Term Asset-Backed Securities Loan Facility. (The Fed calls it TALF. Doesn’t quite roll off the tongue the way TARP does.)

Under TALF, the Fed will lend up to $200 billion to investors who buy securities backed by consumer loans such as credit card debt (but not mortgages). The markets for such asset-backed securities ground to a halt last month because of a lack of buyers. If they remain closed, you may very well see the limit on your credit cards reduced or the cards canceled altogether. You may already have gotten a taste of this from issuers such as American Express and Citigroup. Although that might actually help you put your personal balance sheet in order, if enough people were forced to trim their debt by cutting back on spending, the economy would suffer.

The Fed says it will demand more in collateral (the asset-backed securities) than it will lend under the program. But if the value of the securities falls below the amount it lends, the Fed will be on the hook for the difference.

Still, the central bank implies it will take on minimal risk. But it’s for this program that the Treasury is putting up credit protection. That indicates the risk is significant; otherwise, why protect against it?

But if there are losses, what’s the difference whether it’s the Fed or the Treasury that loses the money? To you, the taxpayer, not much.

-- Arthur Buckler