Fed to Buy CP Directly From Money Market Funds
October 27, 2008
WASHINGTON - Despite signs of renewed strength in the credit markets, the Federal Reserve Board on Tuesday unveiled a new program to provide more liquidity to money market mutual funds.
It is the Fed's second attempt in a month to bolster money market funds. The first program targeted asset-backed commercial paper held by the funds, the second tackled their unsecured commercial paper. The Fed's third program, set to launch on Monday, will purchase commercial paper, both secured and unsecured, from any U.S. issuer.
The moves are designed to provide market players with enough comfort to resume lending.
"It's allaying the liquidity fears that are preventing lenders from extending out on the curve, and that's really the issue," said Lou Crandall, chief economist at Wrightson ICAP. "If you give them an absolute solid secondary market guarantee, it allows them to extend out on the curve."
The Fed said it was reacting to fallout caused by Reserve Primary Fund, a major money market fund, which "broke the buck" in last month and sparked a wave of withdrawals at other funds.
As these funds hoarded cash, they stopped buying bank debt, and that led to banks pulling back from their borrowers. With this latest program, the Fed is trying to break that cycle and get money flowing again.
The Fed's latest program, the Money Market Investor Funding Facility, will consist of five funds that will be run by JPMorgan Chase & Co. and lend up to $540 billion. Initially it will run through April 30, but could be extended.
The Fed will provide the cash, and JPMorgan Chase's five funds, in turn, will purchase from money market funds certificates of deposit, bank notes, and commercial paper with remaining maturities of 90 days or less. With the unsecured assets off their books, money market funds presumably would be more likely to buy bank debt, including commercial paper and CDs.
The newest program is another layer in the Fed's increasingly complex effort to lube the credit markets. Those efforts began with cash auctions last year and now include sales of Treasury securities, sweeping purchases of commercial paper, expanded access to the discount window and relatively liberal requirements governing acceptable collateral.
As with its prior efforts, the Fed says it is taking steps it hopes will minimize taxpayer risk. Debt purchased must have short-term ratings of A-1/P-1/F1 from two or more rating agencies.
The Fed has also essentially hedged some of the risk by paying only 90% of the amount the funds will pay for the debt. The remaining amount would be paid in the form of asset-backed commercial paper, which will absorb the first losses. Senior Fed officials told reporters Tuesday that JPMorgan was selected to run the program by the participating money market funds.
JPMorgan will receive fees that will be funded by a portion of the net interest income generated by the conduits. Though the program should help bank funding, it could create unintended consequences, such as shifting deposits away from the banking system.
Chris Low, chief economist at First Horizon National Corp.'s FTN Capital Financial, said money market funds have lost $500 billion since Lehman Brothers filed for bankruptcy last month. That loss translated into a gain at many banks, he said, in the form of deposits. But that trend could now reverse.
"The immediate threat to banks from this program is one of the intentions to pull deposits out of the banks and back into money markets," he said. "If investors can be reassured that money markets are safe again, they're likely to go back in that direction.
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