Fed Lends $540 B to Money Market Funds

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

The Fed provided additional facility of $540 billion, this time to support the money market mutual funds. In the last five weeks the funds have seen withdrawals of $500 billion as crisis of confidence spreads to short term lending or commercial paper market.

[R]3:10PM New York – The Fed acts to set up a separate facility to support money market funds and may lend as much as $600 billion in the program.[/R]

The Federal Reserve set up a third lending facility to provide additional liquidity in the short term lending market.

The Money Market Investor Funding Facility will provide up to $600 billion in capital. The funding facility will accept commercial paper and other short term instruments from highly rates institutions with less than 90 days of maturities from money market mutual funds only. And ‘over time’ the Fed may include other U.S. money market investors.

Money markets have become popular in the last ten years as investors seek returns that are higher than bank deposits and are liquid. The market has grown from less than $100 billion only 15 years ago to $3.3 trillion. The FDIC recently increased the insurance coverage to bank deposits to $250,000 from $100,000 and to unlimited deposits in money market funds.

The current program was designed after several money market funds faced large withdrawals in the last five weeks. Since the collapse of Lehman Brothers on September 15, the commercial paper market and money market funds have suffered heavily. Several money market funds fell for the first time below $1 a share, a rare event in the short term lending market.

The Fed action is likely to facilitate the redemptions in the money market mutual funds. Nearly $500 billion have been withdrawn from money market funds according to the Fed officials and commercial paper market lending remains tight.

Both large and small corporations use commercial paper to meet they payroll and other short term borrowing needs. But the recent action is largely expected to help large corporation first.

The Fed in the last month had set up two other lending facilities. The asset backed paper or collateralized asset lending to money market funds and a direct lending to businesses in exchange of commercial paper loans.

JP Morgan Chase will manage the lending program under five separate funds. Each fund will work with 10 financial institutions and will not purchase more than 15% of its asset.

The Federal Reserve Bank of New York will commit to lend to 90% of the purchase price of each eligible asset until the maturity of the asset. The loans will be on an overnight basis and at the primary credit rate.

The Fed indicated that it will provide $540 billion in additional capital and will take $60 billion from its existing capital.

Money market funds hold asset backed and unsecured commercial papers that generally mature in less than nine months used by companies to pay for day to day expenses including rent, payroll and other short term receivables. Money market funds hold 65% of unsecured commercial paper and 40% of secured commercial paper.