By Daniel Pimlott in New York
Financial Times | October 7 2008 15:15
The Federal Reserve on Tuesday moved to provide funding to the commercial paper market, which has contracted sharply in recent weeks, putting severe strains on many businesses’ ability to raise short term funding.
In a significant extension of its normal role, the US central bank said it would start buying three-month unsecured and asset-backed commercial paper directly from issuers – many of which are not banks or financial services companies – in order to provide a liquidity backstop to the US commercial paper market.
Commercial paper market is a key forum for large companies to raise short-term finance. The move is intended to assuage fears that the credit crisis will spread to non-financial companies and that companies could find themselves unable to carry out basic functions such as payroll that are often financed by short-term borrowing in the commercial paper market.
The Fed said: “An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.”
The commercial paper market has been under stress as money market mutual funds and other investors have become reluctant to buy commercial paper, especially at longer-dated maturities.
“As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day,” the Fed said.
The commercial paper market contracted by a record $94.9bn in the week that ended October 1 to $1.61 trillion in outstanding debt, Fed data shows, after a $61bn drop the week before.
The programme, to be called the Commercial Paper Funding Facility, is the latest in the series of emergency operations that the Fed has undertaken to ease strains in the credit markets.
It follows the Term Auction Facility, which from last December was used to pump liquidity into the interbank market, and the Term Securities Lending Facility and the Primary Dealer Credit Facility, established amid the Bear Stearns crisis. The TSLF allows institutions to borrow against illiquid assets such as mortgage backed securities, while the PDCF offered overnight loans to provide funding to primary dealers.
“The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy,” the Fed added.
The Fed said it would finance the special purpose vehicle and that it would be secured by all of the assets in the vehicle. In the case of the commercial paper that is not asset-backed, it will be financed through fees paid by the issuers or other forms of security acceptable to the Federal Reserve in consultation with market participants.