Fed Looks To Buttress CP Market
October 7, 2008
The U.S. Federal Reserve on Tuesday introduced a program designed to improve liquidity in the commercial paper market which has seen a drop in willing lenders over recent weeks.
The Fed's Commercial Paper Funding Facility will "complement the Federal Reserve's existing credit facilities to help provide liquidity to term funding markets," the central bank said in a prepared statement.
The new program will provide a liquidity backstop to U.S. commercial paper issuers through a special purpose vehicle. This SPV will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers.
The Federal Reserve will provide financing to the SPV under the funding facility and will be secured by all of the assets of the special purpose vehicle. In the case of commercial paper that is not asset-backed commercial paper, fees are to be paid up-front by the issuers or by other forms of security acceptable to the Fed.
The Fed said in a statement that U.S. Treasury believes this facility is needed to prevent substantial disruptions to the financial markets and the economy. The treasury will make a special deposit at the Federal Reserve Bank of New York in support of this facility.
The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors have become reluctant to purchase commercial paper, especially at longer-dated maturities.
As a result, the volume of outstanding commercial paper has shriveled up sending interest rates on longer-term commercial paper higher. Also, an increasingly high percentage of outstanding paper must now be refinanced each day.
"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 said.
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