Fed to Purchase Commercial Paper

by Erin McCune on October 7, 2008

in Finance

Today's big news (at least so far)… efforts turn to addressing the shortage of short term liquidity. [Read the Fed Announcement]

via Bloomberg:

     Oct. 7 (Bloomberg) — The Federal Reserve will create a
special fund to purchase U.S. commercial paper after the credit
crunch threatened to cut off a key source of funding for

The Treasury will make a deposit with the Fed's New York
district bank to help set up the special purpose vehicle. The
central bank will also lend to the program at policy makers'
target rate for overnight loans between banks. The Fed Board
invoked emergency powers to set up the unit, the central bank
said in a statement released in Washington.      

Today's action follows a slide in the commercial-paper
market to a three-year low of $1.6 trillion last week as
investors fled even companies with few links to the subprime
mortgage crisis. Companies from newspaper firm Gannett Co. to
electricity producer Southern Co. have been forced to tap credit
lines or forego raising debt because of the market's disruption.   

The Fed didn't say how much commercial paper, which hundreds
of companies use to finance payrolls and meet other cash needs,
it plans to purchase.    

Stocks climbed and Treasuries sank after the Fed's
announcement. Futures on the Standard & Poor's 500 Stock Index
gained 1.9 percent to 1,073.60 at 9:15 a.m. in New York. Yields
on benchmark 10-year notes climbed to 3.55 percent from 3.45
percent late yesterday.


The central bank has never bought unsecured commercial paper before.
Traditionally, when the Fed lends to banks and other financial
institutions, they have collateral to back up those loans. In this
case, if a company doesn't put up collateral to back up the commercial
paper, the Fed said it will charge the company a fee.

Also new
is that the Fed has expanded the kinds of companies that can come to it
for help: Now it isn't just financial institutions but instead will be
bread-and-butter companies like General Electric or Caterpillar.
Financial arms of corporations are big users of commercial paper. Among
other things, the Fed's move is expected to help car dealers who have
been having trouble securing loans.

The Fed's move is aimed at
pumping liquidity into the market in hopes of easing a global credit
crunch. The numbers show just how seized up the credit markets have
become. In the week ended Oct. 1, the U.S. commercial paper market
shrank by almost $100 billion to $1.6 trillion, because banks have
started hoarding cash and stopped lending money.

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