In coordinated actions, the Treasury and Federal Reserve Board have created two new lending facilities to deal with the continuing economic crisis. One facility will finance consumer and small business lending that is not secured by mortgages. The other will finance mortgage-backed securities and direct obligations of the government-sponsored enterprises (GSEs — Fannie Mae, Freddie Mac, and the Federal Home Loan Banks).

1. Term Asset-Backed Securities Loan Facility

The Fed on November 25 announced the creation of the Term Asset-Backed Securities Loan Facility (TALF), which will help market participants meet the credit needs of households and small businesses. TALF will support the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).

TALF will enable the Federal Reserve Bank of New York (FRBNY) to lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated asset-backed securities that are backed by new or recently originated consumer and small business loans. The New York Fed will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS.

To support the New York Fed’s lending, the Treasury will provide $20 billion of credit protection through its Troubled Assets Relief Program. By providing liquidity to issuers of consumer asset-backed paper, the Federal Reserve facility will enable a broad range of institutions to step up their lending, enabling borrowers to have access to lower cost consumer finance and small business loans. The facility may be expanded over time and eligible asset classes may be expanded later to include other assets, such as commercial mortgage-backed securities, non-agency residential mortgage-backed securities, or other asset classes.

The agencies explained that they created and funded TALF because the consumer asset-backed securities market has virtually dried up. This market has long been a source of liquidity for financial institutions that provide federally guaranteed small business loans and consumer lending, such as auto loans, student loans, and credit cards. Issuance of ABS in these areas reached $240 billion in 2007, but credit market stresses led to a steep decline in the third quarter of 2008, and the market essentially came to a halt in October.

As a result, Treasury Secretary Henry Paulson said, millions of Americans cannot find affordable financing for their basic credit needs. In addition, credit card rates are climbing, making it more expensive for families to finance everyday purchases. This lack of affordable consumer credit undermines consumer spending and as a result weakens the economy.

The agencies released a terms and conditions document describing how the facility will operate. They warned, however, that the terms and conditions are subject to change based on discussions with market participants in the coming weeks.

2. Fed to Buy GSE Obligations

Separately, the Fed announced that it would initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs) — Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The Fed will also purchase mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae.

The Fed said it took this action because rate spreads on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late. The Fed acted to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets generally.

Purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the Fed’s primary dealers through a series of competitive auctions beginning next week. Purchases of up to $500 billion in MBS will be conducted by asset managers the Fed will select by a competitive process, with purchases likely to begin before the end of the year. Purchases of both direct obligations and MBS will take place over several calendar quarters.