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Fed to Purchase US Commercial Paper
By Craig Torres
Oct. 7 (Bloomberg) -- The Federal Reserve Board, invoking
emergency powers, will create a special fund to backstop the
U.S. commercial paper market in an effort to support the
financing needs of corporations.
The move comes as the credit freeze spreads to the market
for short-term debt that hundreds of companies use to finance
payrolls and meet other cash needs.
The Fed said it will lend against a special purpose vehicle
at the targeted federal funds rate. The unit will purchase from
eligible issuers three-month dollar-denominated commercial paper
at a spread over the three-month overnight-indexed swap rate,
according to a press release in Washington today.
The Fed said the paper purchased by the vehicle must be
rated at least A1/P1/F1. Issuers will pay the unit an upfront
fee based on the commercial paper initially sold to the vehicle.
The vehicle will cease buying commercial paper on April 30,
2009, unless the Board of Governors agrees to extend it.
The Fed yesterday said it will double its cash auctions to
banks to as much as $900 billion, and telegraphed today's announcement by saying it was looking for other ways to
alleviate liquidity strains.
For Related News:
For news on the credit crisis: NI CRUNCH BN <GO>
Top finance news: TOP FIN <GO>
News on Fed loan programs: STNI FEDFACILITIES <GO>
Stories on the U.S. financial bailout: STNI USBANKBAILOUT <GO>
-- Editors: Chris Anstey, Alan Crawford.
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Here's the press release from the Fed:
For release at 9:00 a.m. EDT
The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve's existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that 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 CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of 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 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 at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.
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. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.
Commercial Paper Funding Facility (CPFF) Terms and Conditions (57 KB PDF)
Re: Fed to Purchase US Commercial Paper
Deductive reasoning isn't a conservative or liberal attribute. ~epphd
We've mentioned the CP market every so often in our previous discussions and I think that this is a big gamble that the Fed is taking. The bailout plan used collateralized bonds but commercial paper is unsecured debt. This is a much bigger risk than mortgage backed securities, where the Fed can at least own property and try to regain some value should the whole deal blow up. With commercial paper, the Fed is betting and hoping that the company itself will survive. Given the current environment, this is a bigger risk.
However, I just got feedback from someone in another bank and here are 4 ways that the Fed is protecting US Taxpayer money:
1. upfront fee
2. issuer gets guarntee
3. collateral is posted
4. issuer provides some form of security that is satisfactory to the Fed
I am not sure I believe much of this crap that folks across the street are trying to convince me, but this is supposed to rebuild confidence in the market.
I didn't get a chance to post much recently, but there was a post yesterday about the bailout approval followed by the market tanking. Confidence was already lost when the House denied the bill the first time around. This bear market will continue to have huge ups and down for a while. IMO, the bailout was a good compromise for taxpayers. It helped deter companies from relying on the government to bail them out. The bailout is meant to spur other companies to step in and for those struggling to work even harder to get something done. Nothing will happen overnight and until it is clear how the pricing mechanism will work for the TARP, credit will continue to be be frozen.
My initial reaction is that this will be a big help b/c commercial banks are pretty worried, are they not? Seems like this is a good way to restore liquidity.
Another number close to $1Trillion is scary, but I have no idea how much money they normally deal with. I don't think it's unprecedented. Is that the case?
Yes, banks and companies alike are super worried and in theory it is a good way to restore liquidity. However, as a taxpayer it is not good news for us.
For cash auctions, $900 billion is a relatively large number since I am not sure how much of that will be issued in how many periods.
I just saw an email from a colleague mentioning that the Fed auctioned off $150 billion worth of 3-month dollars and only received demand for $138 billion. This seems to be a bottom since banks were scrambling for this money in the last auction round. Back on 9/22, the Fed auctioned $75 billion and received $133 billion of demand.