The Federal Reserve said Tuesday that would establish a special credit facility to purchase commercial paper from issuers to support businesses and loans.
“Commercial paper markets directly finance a wide range of economic activity, supplying credit and funding for auto loans and mortgages as well as liquidity to meet the operational needs of a range of companies,” the Fed said. “By ensuring the smooth functioning of this market, particularly in times of strain, the Federal Reserve is providing credit that will support families, businesses, and jobs across the economy. ”
The commercial paper market is basically a market for short-term, unsecured loans. Issuers include businesses and investment vehicles that buy longer-term loans. The usually stable market can freeze up when investors fear defaults or decide to hold on to their cash.
That’s what happened in the financial crisis of 2008. In October of 2008, the Fed launched a facility similar to the one it is now creating to purchase commercial paper.
Because the Fed is constrained in the types of assets it can buy, these facilities are funded through secured loans to specially created entities that buy the paper. Those loans are secured by the paper. The Fed said on Monday that the Treasury would provide it with $10 billion of credit protection in connection with the new facility.
This type of facility has not yet been used to purchase assets such as corporate bonds, equity, or non-financial assets but many on Wall Street have noted that the same model could be used on a broader scope if necessary.
“The commercial paper market has been under considerable strain in recent days as businesses and households face greater uncertainty in light of the coronavirus outbreak,” the Fed noted in its statement announcing the new facility.
The Fed also said that it would, alongside other federal banking regulators, encourage banks to continue to lend to households and businesses. In addition, the Fed is once again making up to $500 billion of funds available through the repo market. Yesterday, a Fed repo facility of the same size received bids for just $19 billion, raising concerns that some banks may be pulling back on their own financing activity rather than tapping the Fed’s facilities.