Fed, Lender in Commercial Paper Market

123jump.com Staff
07 Oct, 2008
New York City

The Fed set up a special fund to purchase high quality short term loans in the commercial paper market. The move is likely to improve liquidity and restore confidence in the short term loan market that has faced historic volatility and near seizure in the last few weeks.

[R]10:20 a.m. New York – The Fed acts to restore confidence in the commercial paper market.[/R]

The Federal Reserve acted to enhance liquidity and restore confidence in the short term loan market. The Fed set up a special fund to purchase commercial paper so that issuers can roll over the short term debts to fund the daily cash requirements. The latest move comes after the Fed this Monday provided additional $900 billion in short term lending facility. The Fed continues to flood the financial system with huge liquidity but the numbers are now getting too large even for the Fed.

In the last few months the commercial paper market has nearly dried up as investors facing liquidity crunch have been reluctant to purchase long term dated paper. This has caused larger percentage of short term debt to be financed more frequently and at higher interest rates. Altria, Gannett and Southern Company are few of the large companies that have experienced difficulties and had to use credit lines.

A large share of commercial paper is issued or sponsored by financial intermediaries like Lehman Brothers and Merrill Lynch who are no longer capable of shoring financial risk in the commercial paper market. The lack of capital that bridged the issuer an borrower has impacted amount paper issued and interest rates that are charged.

The commercial paper issuance in the last week dropped to a 3-year low to $1.7 trillion and spread of rate between the treasury and the paper shot up as high as 3.64%. UBS has paid as high as 3.3% for its short term loans and General Electric was forced to pay more than 2.5% for its commercial paper loans.

The money market funds are active and large participant in the market and several funds have been forced to close and return money to their investors. The flight of capital from commercial paper market has lifted U.S. Treasury securities in the recent weeks. The total investment in the money market mutual funds has declined at the end of the last month to $3.5 trillion, according to the industry newsletter Money Fund Report based in Massachusetts.

The investment vehicle set up by the Fed will function till the end of April next year and will need the Board of the Governors approval to extend it. The Fed will purchase paper with rating of at least A1, F1, and P1.

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