Toxic Asset Subsidies and the Early Redemption of TALF Loans

Abstract

This paper develops a formula to numerically estimate the unsubsidized, fair-market value of the toxic assets purchased with Federal Reserve loans. It finds that subsidy rates on these loans were on average 33.9 percent at origination. Yet, by the 3rd quarter of the 2010, there was on average no subsidy in TALF loans. The theoretical model is used to predict the early redemption of Term Asset-Backed Securities Loan Facility (TALF) loans used to purchase commercial mortgage backed securities (CMBS). The predictions of the model are strongly supported by the data. In addition, this paper looks at the determinants of early redemption. CMBS originated inside the peak bubble years of 2005-2007 were much less likely to be redeemed early. The giant investment managers, Blackrock and PIMCO, were much more likely to redeem their TALF loans early than smaller investment managers.

Keywords: Alternative Investments, Bailout, Banking, Blackrock, Call Options, Commercial Mortgage Backed Securities, CMBS, CDOs, Dodd-Frank, EESA, Emergency Economic Stabilization Act, Lending, Legacy Securities Program, Mortgages, PIMCO, PPIP, TARP, Troubled Asset Relief Program

JEL Classification: G12, G13, G18, G21, G28, G38