Fed sets plan for credit markets
Aim is keeping economy going
WASHINGTON — The Federal Reserve on Tuesday took another step to try and prop up the American economy, saying it would begin buying up a type of shortterm debt that companies use for funding, known as commercial paper, to help keep credit flowing to households and businesses.
The program, enacted using the Fed’s emergency lending powers, pulls a page from the central bank’s 2008 financial crisis playbook and is an attempt to keep the economy and financial system functioning by backstopping a market that some of America’s biggest companies use to raise cash.
Large businesses issue commercial paper, which is essentially IOUs, to raise cash to meet payrolls and cover other short-term costs.
Banks and companies have been issuing commercial paper to shore up their coffers as coronavirus leads to quarantines, shutters shopping centers and closes restaurants. But hardly anybody has been buying the debt.
Treasury Secretary Steven Mnuchin, whose department will provide $10 billion of credit protection
to the Fed using the Treasury’s Exchange Stabilization Fund, said the facility would allow the central bank to buy about $1 trillion worth of commercial paper “as needed.”
Mnuchin, speaking at a news conference Tuesday, said that while the Fed may not need to purchase that total amount, the facility “has already created significant stability in the market today.”
The Fed program will use a special vehicle to buy unsecured and asset-backed commercial paper from eligible companies, according to a statement by the central bank. That should benefit financial firms and ordinary businesses alike.
“Commercial paper markets directly finance a wide range of economic activity,” the Fed said, noting that they supply “credit and funding for auto loans and mortgages as well as liquidity to meet the operational needs of a range of companies.”
Borrowing rates in the commercial paper market have been spiking as more companies have sought to raise cash in the expectation that their revenue will plunge.
At the same time, money market funds, among the largest buyers of the shortterm loans, are seeking to sell commercial paper themselves. They need to raise money because they expect large institutional investors to withdraw funds, and they need cash to cover those withdrawals.
All that activity has made it harder for banks and other companies to raise the cash they need.
The program should act like an escape valve, snapping up notes to keep cash flowing, much as it did during the 2008 financial crisis, when credit markets largely froze.
The Fed’s move comes on the heels of the sweeping actions it took Sunday, when it slashed rates nearly to zero and announced a program to buy up government debt and mortgage-backed securities. Those purchases are also meant to ease strained markets, including that for Treasury securities — which had become hard to trade, a problem because they are in many ways the backbone of the financial system.
The Fed has also sweetened the terms of its so-called discount window, which allows banks to tap short-term loans from the Fed. It has encouraged big banks to begin using the program to overcome stigma associated with using the discount window, and the nation’s biggest banks said Monday night that they had each used the program. Regulators have also been providing limited regulatory relief to banks to keep credit flowing.
In the wake of the 2008 financial crisis, regulators had forced big banks to hold on to trillions of dollars in assets that are very easy to trade in case a crisis forced them to raise cash quickly. On Tuesday, regulators told the banks that they can start to sell off some of those instruments and encouraged them to use the cash to lend to struggling businesses.
But investors have been clamoring for more, especially as the commercial paper market seized up.
“This Fed facility ensures that companies can get the overnight funding they need to meet short-term obligations like payroll,” said Ernie Tedeschi, policy economist at Evercore ISI, calling it “obviously a positive step, obviously necessary.”
“The only surprising thing is that it took them this long to do it,” he said.
As companies have struggled to raise cash by issuing commercial paper, it has threatened to set off a chain reaction. Firms have been drawing on lines of credit and pulling money from prime money-market mutual funds to secure cash. Those money funds — low-yield, safe investment vehicles — need to sell their commercial paper holdings to give back cash, but that’s hard to do in a barely functioning market.
As investors and corporations become concerned about the availability of cash, it could trigger an even bigger rush for it. That’s putting pressure on banks to free up their own liquidity to meet demand, which keeps them from serving as an intermediary in other crucial markets. The result is that the gears of the financial system are beginning to get stuck, hampering trading in everything from Treasuries to corporate debt.
“I think we’re either entering a financial crisis or already there,” Jon Hill, a rates strategist at BMO Capital Markets, said Monday.
Many analysts say they expect the Fed to revive other financial-crisis-era programs in the coming days, including one known as the term auction facility, or TAF. This facility allows a wider array of banks to borrow from the Fed and to pledge a range of collateral, such as corporate bonds, rather than just Treasuries.