The Fed announced plans to purchase commercial paper directly from issuers. The plan will be backed up by taxpayer funds, with the Treasury Department making a special backstop deposit at the Fed.
The plan looks a lot like a reversal of The Entity, that Super-SIV that a consortium of banks launched last year in an attempt to buy up assets of conduits that held long term debt and funded themselves with short term and commercial paper. That plan didn’t work out because there weren’t buyers for the short term paper of the Entity either.
Here the Fed will form a special purpose vehicle that will buy commercial paper directly from borrowers. The vehicle will be funded through a new lending facility, the Commercial Paper Funding Facility, that will loan money against the asets purchased by the SPV. So the Fed lends to CPFF, which buys commercial paper that secures the loans the Fed lent. This neatly gets around any issue about whether the Fed should be in the business of making unsecured loans since it won’t be lending directly to commercial paper issuers. Additional collateral, in the form of fees from commercial paper issuers that sell to the SPV, will be required for comemercial paper that is not asset backed.
The purpose of the Entity was to allow banks to avoid taking troubled debt instruments held in off-balance sheet vehicles onto their books when they became impossible to fund in the commercial paper market. The purpose of this reverse entity is to get directly at the commercial paper market, juicing it up with Fed money backed by taxpayer funds. But the method is the same: create another off-balance sheet special purpose vehicle.
In addition to loosening the credit markets, this massive new bailout might save GE.
Here’s the Fed’s statement on the stress on the commercial paper market.
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.
See Also: The Bomb That Is Blowing Up In GE’s Hold