The Fed announced this morning a new attempt to jump start the asset-backed securities (ABS) market. FRB: Press Release–Federal Reserve announces the creation of the Term Asset-Backed Securities Loan Facility (TALF)–November 25, 2008:
The Federal Reserve Board on Tuesday announced the creation of the Term Asset-Backed Securities Loan Facility (TALF), a facility that will help market participants meet the credit needs of households and small businesses by supporting 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).
Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. The FRBNY 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. The U.S. Treasury Department–under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008–will provide $20 billion of credit protection to the FRBNY in connection with the TALF. The attached terms and conditions document describes the basic terms and operational details of the facility. The terms and conditions are subject to change based on discussions with market participants in the coming weeks.
TALF Terms and conditions
It looks like the Fed and the Treasury are trying to go to the root of the issue by supporting old fashioned straight-up ABS deals. As the Fed press release noted, the ABS market came to a complete halt in October.
This is good news for intangible asset monetization. Intangible asset deal have tended to be the straight-up type. Getting the fundamental ABS market restarted opens the door to future intangible-backed deals. In addition, as the terms and conditions description points out:
The set of permissible underlying credit exposures of eligible ABS may be expanded later to include commercial mortgage-backed securities, non-Agency residential mortgage backed securities, or other asset classes.
Could “other asset classes” include intangibles? Maybe, just maybe.
Here is an interesting quote from a very high ranking government official on the stimulus package (as quoted in today’s Financial Times): “Spending must be smart spending.” He went on to say, “We must invest in those areas that are critical to our future competitiveness – essential infrastructures, research and innovation, clean technologies to support the transition to the low-carbon economy, energy efficiency, and education and training.”
No, it was not Larry Summers. It was José Manuel Barroso, European Commission president at a conference last Friday.
The point is that other nations are going to do the same things we say we are going to do to promote long term competitiveness. If that is the case, then we need to be doubly smart. To stay ahead of the game, we will also need a strategy. Saying we want to take the lead by being green is like every city and region in the country saying they what to take the lead by becoming like Silicon Valley. A much finer tuned strategy is needed.
For that reason, now is the perfect time to create a Commission on the Future of the US Economy. It would be patterned after the 1980’s President’s Commission on the Industrial Competitiveness (the Young Commission), which proved to be a successful mechanism for confronting the issues of its time. But this new Commission would take on the current problems, which are fundamentally different compared with 20 years ago. It would craft new policies and a new long term strategy for economic prosperity. Thus it would be a great compliment to the short term strategy laid out by President-elect Obama.
Speaking of the valuation problem, here is an interesting tidbit. Intangible valuation may have become a factor as a sideline to a brawl between the current management of the European discount airline easyJet and its founder, Sir Stelios Haji-Ioammou. In a dissenting letter at the end of the company’s Preliminary Results 2008, Sir Stelios made the following statement:
I believe the methodology by which easyJet ascribed value on its own balance sheet to the Gatwick landing slots that came for free with GB Airways is based on optimistic assumptions about future revenues, particularly in the current economic climate. Given the fact that many airlines have already ceased operating from Gatwick I believe that slots will be freely available and hence it will be more prudent not to create Gatwick slots as an “intangible asset” on our own balance sheet this year.
The preliminary financial statement had this to say about these intangibles:
Goodwill and landing rights at Gatwick have indefinite expected useful lives and are tested for impairment annually or where there is any indication of impairment. They are stated at cost less any accumulated impairment losses.
Landing rights at Gatwick are considered to have an indefinite useful life as they will remain
available for use for the foreseeable future provided minimum utilisation requirements are
So there is a clear difference in assumptions that drive the different valuations.
All of this may ultimately have nothing to do with intangibles – but a fight over other matters, such as dividends and strategy (see stories in The Guardian and The Economist). Still, it is interesting to see how assumptions as to the valuation of intangibles can become an important bone of contention.
In an earlier posting, I mentioned that the action with regard to toxic assets seems to have shifted from Treasury to the Fed. That shift, however, comes with its
won own set of problems on how to handle the collateral and on price discovery.
A story in this morning’s Washington Post (Fed Has Giant, and Opaque, Role in Financial Crisis Aid) makes the same point on the role of the Fed:
As of last week, the Fed’s loans included $507 billion to banks, $50 billion to investment firms, $70 billion for money market mutual funds, and $266 billion to companies that use a form of short-term debt called commercial paper. It is considering a new program that would make billions more available to prop up consumer lending: auto loans, credit cards and the like.
In lending these vast sums, the Fed is essentially substituting its own unlimited ability to supply cash for that of private markets, which are not functioning normally. The central bank is even fulfilling some of the original goals of the Treasury Department’s $700 billion rescue program by allowing financial institutions to use securities that are difficult to sell as collateral for loans.
. . .
The Fed’s lending achieves some — but only some — of the goals of the Treasury Department’s original financial rescue plan. The Troubled Asset Relief Program, which is now focused on investing money in banks, was originally intended to focus on the purchase of mortgage-backed securities.
Although not purchasing such securities, the Fed has agreed to take them on as collateral. That has helped banks get access to cash. But banks are still exposed to further losses if the value of those assets continues to decline. And the lending is not jump-starting the market by serving as a buyer of last resort, which would be the goal of government purchases.
“It’s kind of like TARP light,” said Michael J. Feroli, an economist at J.P. Morgan Chase.
With virtually unlimited resources, the Fed can act as lender of last resort. The problem here, however, is two fold. First, the toxic assets are not being purchased and taken off the books. They are simply being used as collateral. Banks will still have to write off the bad assets at some point — with the corresponding hit to the bottom line. And it is unclear whether using the assets as collateral makes it easier or harder to write off the loans. Under a normal commercial transaction, the borrower can’t simply dump the collateral. It has to stay on the books to play its role. A write down of the collateral would cause the lender to call in the loan. So following normal procedures, using toxic assets as collateral would be a disincentive to take the write- down. But these are not normal times and we do not know what the terms of the Fed loans are. It could very well be that the Fed will be the one to write off assets, by taking control of the bad assets in exchange for writing off the loans. That would be an interesting mechanism of indirect purchase of the toxic assets.
This brings us to the second problem. The Fed is not required to disclose those loans or describe the collateral used for the loans. Some news organizations, notably Bloomberg, have gone to court to get that information. But others feel it is wise to keep that information confidential, to prevent a run on the borrowing institutions. Be that as it may, the problem here is one of a lack of price discovery. The lack of disclosure means that the Fed does not have to publicly value those assets. This neatly sidesteps the valuation issue — but also does not provide for any price discovery. And right now, the discovered price for these assets is quickly approaching zero — which is why the lending market is freezing up again.
We still need a forcing function to get the bad assets priced and written off the books. Maybe the indirect Fed collateral approach will work. We can only hope.
David Herszenhorn’s piece in today’s New York Times (Congressional Memo – Lame Duck? The Dodo Seems a More Apt Bird) explains exactly what I was saying yesterday as to why nothing will get done this year on solving the economic crisis:
Several Republican lawmakers who are either retiring or were defeated said they would not support aid for the auto industry. And their impending departures gave them little or no incentive to compromise, evidence of why postelection sessions are dicey.
Consider Senator John E. Sununu, Republican of New Hampshire, who lost his bid for a second term, and who on Wednesday objected to a bill offered by Senator Barbara A. Mikulski, Democrat of Maryland, to help the auto industry. Ms. Mikulski snarled, “Boy, am I sorry that is the last act of John Sununu in the Senate.”
Mr. Sununu returned to the floor later. “Well, it won’t be the last thing I do,” he said. “If nothing else, the last thing I will do is explain why her legislation was such a terrible idea.”
The Republican leader, Senator Mitch McConnell of Kentucky, knew that this week offered one of his last moments, ahead of two years of wider Democratic control, to dictate what could or could not get through the Senate.
And Mr. McConnell made clear that he opposed any new money for Detroit and would only support speeding up access to $25 billion in federally subsidized loans already approved. Democratic leaders rejected that idea, leaving the automakers empty-handed.
Not a good start to “bipartisanism.” Remember, if a bipartisan solution is to be reach, both sides have to be willing to play. So far, the actions of the GOP in either the House or the Senate are not encouraging. Hopefully, January will bring a different tone to Washington.
In an earlier posting, I mentioned the “not invented here” syndrome. Usually this trait is thought of as applying only to organizations. The concept of “open innovation” is an attempt to overcome the NIH problem.
But the dangers of NIH also applies to nations. A major part of any National Innovation System (to use the fancy title academics have given it) is the ability to absorb and utilize innovation. Two recent studies have highlighted the issue.
First is a report from the UK’s NESTA: Innovation by Adoption. NESTA is the National Endowment for Science, Technology and the Arts — and is Britain’s chief innovation agency, something like our NSF but with a much broader mandate on innovation.
As the NESTA report states:
The capacity to absorb external knowledge was identified as early as the 1950s as playing a major role in bridging economic development gaps between places. The new ideas and innovations brought by migration, trade and foreign investment networks cannot be fully captured and exploited if a place lacks the internal ability to absorb external knowledge.
So, the capacity of places to innovate depends on internal and external sources of knowledge, which complement each other. Traditional innovation policy has ignored the importance of external knowledge in developing local innovation capacity. But a place needs both to be able to draw in good ideas from elsewhere – an innovation absorptive capacity (AC) – and to use them to create new products and services – an innovation development capacity (DC). This is what the report describes as the AC/DC model. Absorptive capacity allows a place to identify, value and assimilate new knowledge. The development capacity of a place allows it to exploit that knowledge. The extent to which different places draw on ‘AC’ or ‘DC’ to create new value differs across economic sectors.
Five main components are essential to any innovation system. Three of these elements form the ‘absorptive capacity’ components of the AC/DC model: (1) the capacity to access international networks of knowledge and innovation; (2) the capacity to anchor external knowledge from people, institutions and firms; and (3) the capacity to diffuse new innovation and knowledge in the wider economy. The two components of the ‘development capacities’ element of the AC/DC model are (1) knowledge creation and (2) knowledge exploitation.
The second report is from Harvard Business School: “An Exploration of Technology Diffusion.” The authors found that:
• The remarkable development records of Japan between 1870 and 1970 and of the so-called East Asian Tigers in the second half of the 20th century all coincided with a catch-up in the range of technologies used with respect to industrialized countries.
• Adoption lags account for at least 25 percent of cross-country per capita income differences.
The laypersons summary – from Booz & Co.’s Strategy + Business (“The Importance of Adopting New Technologies”) is:
Technology adoption, the cost of producing capital goods, and per capita income growth may be inextricably linked. As a result, to compete in today’s global economy, countries must learn how to quickly leverage new technologies to ensure that their workforces remain competitive.
But in the United States, we pay little attention to the absorption issue. Why? Well the Harvard study inadvertently highlights the issue: an adoption strategy is for catch-up nations. In other words, “developed” nations don’t have as much to learn: NIH
The Booz & Co., analysis of the results understands the broader ramifications. If you are going to stay ahead in this global competitive economy, you have to continue to run fast. That includes utilizing technology from whatever source. As the NESTA report finds, it is a case of AC/DC. Both absorption and development are needed.
So where is the US innovation policy to promote absorption? We have an underfunded MEP (Manufacturing Extension Partnership) program that can’t even look in the direction of the largest part of our economy: services.
Time to rethink our policies.
Call it the “do nothing” bear market. As the Wall Street Journal noted:
The market seesawed between gains and losses but began a steep slide around 2 p.m. Eastern as new remarks from senior government officials cast doubt on the likelihood of a new round of federal aid to Detroit’s troubled car makers.
With the Bush Administration seeming to completely step away from any responsibility and the Senate GOP bound and determined to scorch the earth as they head out the door, I suspect the market news will only get worse as the weeks go on (as I noted in my earlier posting).
By the way, expect that those on the political right will try to blame Obama for all this — just like everything that has gone wrong in the past eight years has been the fault of Clinton, Johnson, Kennedy or FDR.
Yesterday, the Obama-Biden Transition Team announced its Policy Working Groups. Of specific interest are the “Economic” work group headed by Dan Tarullo and the “Technology, Innovation & Government Reform” group headed by the the trio of Blair Levin, a telecom policy expert, Sonal Shah head of Google.org’s global development efforts and Julius Genachowski, co-founder of Rock Creek Ventures and LaunchBox Digital.
I must say I find the grouping of “Technology, Innovation & Government Reform” a little strange. Innovation is much more than technology. And I’ve not sure why the government reform part is in there. I also find it interesting that the three heads are IT and telecom folks — no one from science or other technology areas.
It sounds like the focus will be on technology utilization with in the government and on telecom policy. I hope they can broaden the focus to include a larger focus on innovation (see for example Bruce Nussbaum’s piece on innovation policy). At a minimum I hope they are working with both the Economic group and the Energy & Environment group (headed by former EPA Director Carol Browner).
Besides all other other news yesterday (major deflation; stock market below 8000; looming possibility of auto companies’ bankruptcy), there are a couple of other disquieting tidings.
First is the state of the credit markets. As the FT report, (in Ugly reaction to Tarp U-turn):
US mortgages and credit markets on both sides of the Atlantic have been severely jolted since the US Treasury turned its back on plans to use some of its $700bn in financial bail-out funds to buy troubled assets from banks.
More than a week has passed since Hank Paulson, the Treasury secretary, changed the parameters of the troubled asset relief programme (Tarp). Yet despite Mr Paulson’s insistence to Congress this week that policy actions were starting to bear fruit, the picture on the ground in the credit markets has turned uglier.
Next is the fact that the Bush Administration has apparently gone into Hoover mode. The Washington Post ran a story this morning (After Wall Street Rescue, Bush Changes Course on Federal Intervention) that:
Bush is likely to spend his last months in office arguing against major new government interventions, according to administration officials and GOP lawmakers. Treasury Secretary Henry M. Paulson Jr. has signaled that he is unlikely to seek congressional approval for more bailout money this year.
In other words, nothing much is going to happen to help the economy until January 20. We may see a limited bridge loan to the automakers. And maybe a very limited increase in unemployment insurance. But for the next two months, the economy is essentially on its own. And on its own is a scary proposition right now.
Looks like a very gray Christmas.
It appears that many tech companies have gotten themselves into a bind. As the New York Times (Convertible Debt Is Hanging Heavy) reports:
Technology companies have issued gobs of convertible debt to raise financing in recent years. These securities, loans that convert to equity, are starting to come due, putting the companies in a bind. Investors who own them probably won’t want to convert them into shares, so the companies will probably have to pay the debt off or refinance it. But the former would drain precious cash, while the latter is absurdly expensive.
For years, the match seemed perfect. Companies ranging from Micron, the memory giant, to Anadigics, a niche chip maker, needed cash upfront to develop products. Because they had few assets to offer as collateral, conventional debt was often too expensive. But tech companies could promise future profit, and their stocks are typically volatile. Those factors make stock options valuable. Convertibles are essentially bonds with these options attached, so the companies could issue them with low interest rates. (emphasis added)
What do you mean “they has few assets to offer as collateral”? It is not that they have few assets. They are asset rich, in terms of intangibles. But those assets are hard to use as collateral.
Let me stress this point — tech companies financed themselves based on the promise of future growth because they could not raise funds based on their intangible assets.
A perfect example of why we need a financial system that will utilize intangibles as collateral.