Fed Restarts Commercial Paper Facility to Ease Market Strain

The Federal Reserve will restart a financial crisis-era program to help U.S. companies borrow through the commercial paper market after it came under “considerable strain” due to the coronavirus pandemic.

The central bank is using emergency authorities to establish the Commercial Paper Funding Facility with the approval of the Treasury secretary, according to a Fed statement on Tuesday. The Treasury will provide $10 billion of credit protection from its Exchange Stabilization Fund.

The move follows mounting pressure to act after the Fed’s Sunday evening emergency interest-rate cut to nearly zero and other measures failed to stem market strains as investors reacted to the risk that the virus will tip the U.S. and global economy into a potentially damaging recession.

Help Businesses

“By providing short-term credit, the CPFF will help American businesses manage their finances through this challenging period,” Treasury Secretary Steven Mnuchin said in a separate statement.

The Fed said it will provide financing to a special-purpose vehicle that will purchase A1/P1 rated commercial paper from eligible companies, and purchases will last for one year unless the Fed extends the program.

Pricing will be based on the then-current 3-month overnight index swap rate plus 200 basis points, and each issuer must pay a facility fee equal to 10 basis points of the maximum amount of its commercial paper the SPV may own.

“This provides a backstop and allows institutions to continue to rely on commercial paper to fund their short-term operations, so that’s good” said Roberto Perli, a former Fed economist and partner at Cornerstone Macro LLC in Washington.

Market Relief

Cross-currency basis swaps recovered from multi-year lows reached earlier on Tuesday amid speculation that the Fed could reintroduce the commercial paper facility and maintained those retracements after the central bank announced the news.

Still, three-month euro cross-currency basis swaps remain notably wider than they have been on average this year.

There was, however, some relief in broader markets with stock prices bouncing and the dollar strengthening immediately after the announcement. The S&P 500 index extended gains after earlier reversing losses, to trade 4.5% higher.

Not Generous

Perli said he was somewhat surprised by the facility’s pricing, at 2 percentage points above the overnight index swap rate. “That’s a big premium,” he said. “That’s not particularly generous or lenient.”

The step comes as central banks and governments around the world roll out emergency liquidity measures for markets and economic stimulus programs designed to soften the impact of the spreading coronavirus. A number of economists have said virus-triggered closures and national lock-downs are making a global recession increasingly likely.

The Fed on Sunday slashed interest rates to nearly zero, announced enhanced dollar swap lines with other central banks and said it would buy at least $700 billion in Treasuries and mortgage backed securities to ensure market functioning and keep credit flowing.

Flight to Safety

In financial markets, the rush of investors into cash and other safe havens has threatened to deny companies a crucial source of short-term lending. Firms frequently issue commercial paper — IOUs that generally mature in fewer than 270 days — to fund everyday expenses, like rent and payroll.

The facility reprises a program the Fed rolled out in the depths of the financial crisis in October 2008 as global credit markets seized up. At the time, companies were even more reliant on short-term lending and the crisis left several industrial giants, including General Electric Co., scrambling for cash.

The controversy that surrounded that program, and several other facilities implemented during the crisis, however, spurred lawmakers to put greater restrictions on the Fed’s use of emergency lending.

Under changes created by the Dodd-Frank Act, the Fed has to secure permission from the U.S. Treasury to purchase commercial paper, and must also report to Congress on the program’s recipients and the collateral that is offered to secure the loans.

Despite clearing those hurdles, the step could prove controversial again, with some Democrats likely to call it a bailout for corporations and banks while Americans struggle to pay bills. Some Republicans may also attack it as unnecessary government intervention in the market.

— With assistance by Rich Miller, and Alex Harris

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