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WASHINGTON: The US Federal Reserve opened up its coffers on Tuesday to companies hit by the credit crunch with a new programme that will buy up commercial paper, short-term debt critical for many corporate operations.
The latest effort in an all-out war against the credit crunch creates a new "liquidity backstop" for corporate finance and was established after the US Treasury determined it was "necessary to prevent substantial disruptions to the financial markets and the economy," the central bank said.
The Fed gave no estimate of how much money would be devoted to the programme but said the US Treasury would "make a special deposit" at the New York Fed to get the programme rolling.
The effort is aimed at getting banks and other portfolio managers to buy and sell commercial paper, short-term securities issued by companies and banks for payrolls and other day-to-day expenses.
John Ryding, economist at RDQ Economics, said most of the funds for the programme are likely to go to banks and financial companies that have been trying to roll over debts linked to troubled real estate investments.
"This is basically unsecured lending to the banks," Ryding said.
Most of the funding "isn't likely to go to industrial America, but to financial America. But if the financial companies are locked out of the market their ability to lend to corporate America becomes impaired."
The market for commercial paper has been virtually frozen in recent weeks with banks and other financial firms reluctant to take on any risk and pumping their cash into US Treasury bills, which are guaranteed.
"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 longer-dated maturities," the Fed said.
Ryding said the Fed action is "a factor to prevent things from getting worse" in credit markets.
"It restores confidence to a segment of the market. But does this restore confidence between banks which is the heart of the problem now? No."
The moves puts the central bank on the line in some cases for unsecured commercial paper, but the Fed said the loans would be secured by fees and other collateral arrangements "that are satisfactory to the Federal Reserve."
The announcement creates a Commercial Paper Funding Facility (CPFF) "that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers," the Fed said.
The Federal Reserve will provide financing to a special entity under the CPFF "and will be secured by all of the assets" of this entity.
The Fed said the credit would be available to "eligible issuers," but offered few details. It said it would be open to US companies and other US issuers with a foreign parent firm.
Companies will pay up-front fees or provide "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 and will make a special deposit at the Federal Reserve Bank of New York in support of this facility," the Fed said.
Joel Naroff at Naroff Economic Advisors said the Fed may be taking on some additional risk for its finances but needs to take such action.
"If they get us through the crisis without a major recession, the risk is going to be relatively limited," he said. "The alternative is not to do it and have the credit market lock up."
The programme will buy three-month commercial paper that is either unsecured or asset-backed - using the company's holdings as collateral that have been rated as investment grade.
Commercial paper that is not backed by assets "must be secured to the satisfaction of the Federal Reserve," the Fed said. This may be through an upfront fee or other guarantee or other collateral arrangements. - AFP/de
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