TALF: ‘the great liquidation’ begins for hedge funds and shadow banks

An article in the Financial Times caught our eye that makes plain that the TALF (Term Asset Security Program) is a bailout for the shadow banking system (HT Tom). The bailouts for the banking industry continue unabated despite a change in Administration on January 20th. The Obama Administration has topped up bailout money for Bank of America, AIG and Citigroup, three of the weakest ‘too big to fail’ institutions without putting them through a bankruptcy process.

Now, the Federal Reserve and the Administration are set to move on the TALF program which we chronicled here in three earlier posts, “TALF: A bailout if one reads the fine print,” “TALF details suggest Obama doesn’t get it,” and “A few words from a reader on TALF mechanics.”

Here is what the FT had to say (my highlighting included):

When a group of men who got rich by buying low and selling high want to make you their partner, hang on to your wallet. That bit of financial wisdom was amply demonstrated by the 97 per cent peak to trough drop in the common stock of Fortress Investment Group on its second anniversary as a public company last month. Leverage cuts both ways, and its impact has been almost entirely bad for the alternative asset manager with the low point being a temporary halt to redemptions at its Drawbridge hedge fund late last year.

But investors looking over the detritus left by the financial crisis seem suddenly to realise that, having survived so far, Fortress is ideally suited to reap a future bonanza. They looked past a hefty net loss for the fourth quarter and bid Fortress’ shares up as much as 40 per cent yesterday on hearing its optimism about participating in the first round of the term asset-backed securities loan facility. Fortress is one of a handful of groups that retain the size and credibility to play a role in what may prove to be a high reward and relatively low-risk exercise. Fortress executives dub the coming period “the great liquidation”.

Meanwhile, much of the bleeding has stopped in Fortress’ existing business. About 82 per cent of its capital is long-term in nature with an average remaining life of 9.2 years, leaving plenty of time for mark-to- market losses to be reversed. With important debt renegotiations and redemptions mostly behind it, nasty surprises are unlikely. Management’s optimism about the future of their hedge fund business may sound like bluster after huge outflows and no inflows recently, but it is not so implausible. If it can build new funds while using the taxpayer as a low cost prime broker, new investors should be willing to let bygones be bygones.

I won’t go into specifics here because we have chronicled that in the prior three posts. The crux of the matter is the ‘Great Liquidation.’ Financial service companies in the shadow banking system like Fortress are now able to rid themselves of a good portion of their Level-3 hard-to-price, so-called toxic assets. Now, mind you, these assets must be rated AAA and will be taken on as collateral for a haircut. But, I sense the Fed will be stuck with these assets for quite some time as the loans they are giving for them are non-recourse.

What was once ‘You Walk Away‘ for home owners on their non-recourse mortgages is now you walk away for hedge funds and broker-dealers.

Quoting a good friend, this is “a huge windfall for the hedge fund industry. This whole exercise is designed as much as possible to restore the status quo ante. That’s the real scandal.”

Flying Fortress – FT Lex

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