Cash Management

Fed to “Backstop” Commercial Paper

Fed will use a special purpose vehicle to purchase certain eligible unsecured and asset-backed securities, helping thaw a near-frozen market.
Stephen TaubOctober 7, 2008

In a stunning move to help thaw the nearly-frozen commercial paper market, the Federal Reserve Board announced plans to support the crucial short-term funding vehicle for corporations.

The Fed said it created the Commercial Paper Funding Facility (CPFF), which will complement the Federal Reserve’s existing credit facilities, designed to provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle. The SPV will purchase three-month unsecured and asset-backed commercial paper directly from “eligible issuers,” it said.

The Fed will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV. Commercial paper that is not asset-backed will be secured by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants.

“The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy,” the Fed said in a press release.

It added that it will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

News of a pending announcement began to circulate hours ago, and was carried on the Associated Press and Reuters, who cited an unnamed source. Those stories also said that the Treasury Department was involved in the planning.

In its statement, the Fed noted that the commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase 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, it noted.

A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households, the Fed further explained.

“By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market,” the Fed noted. “Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper.”

It also stressed that an improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.