Fed to buy up commercial paper JEANNINE AVERSATuesday, October 07, 2008WASHINGTON — The Federal Reserve announced Tuesday a radical plan to buy massive amounts of short-term debt in a dramatic effort to break through a credit clog that is imperilling the economy.
The Federal Reserve, invoking Depression-era power under “unusual and exigent circumstances,” will buy “commercial paper,” a short-term financing mechanism that many companies rely on to finance their day-to-day operations, such as purchasing supplies or making payrolls.
The $99.4-billion (U.S.) daily market for this crucial financing, which relies on investors rather than banks, has virtually dried up. Most investors have become too jittery to buy paper for longer than overnight or a couple days.
That has made it increasingly difficult and expensive for companies to raise money to fund their operations. Commercial paper is a way of borrowing money for short periods, typically ranging from overnight to less than a week.
The unstable situation has left many companies vulnerable.
The notion under the plan is for the government to provide a “backstop” that would give companies a new place to get cash, the Fed said. The action makes the Fed a source of credit for non-financial businesses, in addition to commercial banks and investment firms.
The Fed's action helped lift investors' spirits. The Dow Jones industrials rose 145 points in early trading, a day after a huge selloff put the Dow below 10,000 for the first time in four years.
The Fed said it is creating a new entity to buy three-month unsecured and asset-backed commercial paper directly from eligible companies.
“The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors” have become increasingly reluctant to buy commercial paper, especially longer-dated maturities. As the market for commercial paper shrank, the Fed said rates on the longer-term debt “increased significantly,” making it more expensive for companies to borrow.
The Treasury Department, which worked with the Fed on the program, said the action is “necessary to prevent substantial disruptions to the financial markets and the economy.”
The Treasury will provide money to the Federal Reserve Bank of New York to support the new program, the Fed said. It did not say how much.
If a company's commercial paper is not backed by assets or other forms of security acceptable to the Fed, the company could pay an upfront fee, the central bank said.
The Fed said it hoped its effort would jolt the commercial paper market back to life.
“This facility should encourage investors to once again engage in term lending in the commercial paper market,” the Fed said. That should eventually spur financial companies to lend to each other and to their customers, including consumers, the Fed said.
The Fed said it planned to stop buying commercial paper on April 30, 2009, unless the Federal Reserve board agrees to extend the program.
There was $1.61-trillion in outstanding commercial paper, seasonally adjusted, on the market as of last Wednesday, according to the most recent data from the Fed. That was down from $1.70-trillion in the previous week. Since the summer of 2007, the market has shrunk from more than $2.2-trillion.
Pressure also is growing on the Fed to reverse course and order a deep reduction in its key interest rate, now at 2 per cent. Such a move would be aimed at reviving the moribund economy by encouraging consumers and businesses to boost their spending. Many predict the Fed will act on or before its next meeting on Oct. 28-29. And, some believe it could be part of a broader co-ordinated move with central banks in other countries.
Fed Chairman Ben Bernanke may offer clues on the Fed's next move when he speaks Tuesday afternoon on the economic outlook and developments in financial markets.
President George W. Bush also was set to talk about the government's $700-billion bailout effort, which lets the government buy rotten mortgages and other bad debts from banks and other financial institutions. By getting these bad debts off bank's balance sheets, they might be in a better position to raise capital and more willing to lend to each other and to customers.
The Fed pledged Monday to take “additional measures as necessary” to battle the worst credit crisis in decades.
Treasury Secretary Henry Paulson has tapped a former Goldman Sachs executive to be director of the government's bailout program. Neel Kashkari, who has worked with Mr. Paulson at the department since July 2006, was chosen Monday as the interim head of the government's unprecedented effort to unclog the credit markets.
Mr. Kashkari, who was a vice president in Goldman's San Francisco office before joining the department, is one of four former executives from the firm now working feverishly to resolve the financial crisis.
The lending lockup is a key reason why the U.S. economy is faltering. Unable to borrow money freely or forced to pay a high cost to borrow, employers are cutting jobs and reducing capital investments.
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