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XMFSinchiruna (26.40)

What's another $100 billion?



October 07, 2008 – Comments (2)

With the announcement of its latest facility to pump liquidity into the markets, the Fed this time did not specify the size of the facility nor any limits thereon. Therefore, for Fools like me trying to keep a rolling tab on the total outlays for this crisis to date, we can only estimate using the reported size of the daily market for this category of debt: $100 billion.

WASHINGTON - The Federal Reserve announced Tuesday a radical plan to buy massive amounts of short-term debts in a dramatic effort to break through a credit clog that is imperiling the economy.

The Federal Reserve, invoking Depression-era power under "unusual and exigent circumstances," will buy "commercial paper," a short-term financing mechanism that many companies rely on to finance their day-to-day operations, such as purchasing supplies or making payrolls.

The $99.4 billion daily market for this crucial financing, which relies on investors rather than banks, has virtually dried up. Most investors have become too jittery to buy paper for longer than overnight or a couple days.

That has made it increasingly difficult and expensive for companies to raise money to fund their operations. Commercial paper is a way of borrowing money for short periods, typically ranging from overnight to less than a week.

The unstable situation has left many companies vulnerable. The notion under the plan is for the government to provide a "backstop" that would give companies a new place to get cash, the Fed said. The action makes the Fed a source of credit for nonfinancial businesses in addition to commercial banks and investment firms.

The Fed's action helped lift investors' spirits. The Dow Jones industrials rose 145 points in early trading, a day after a huge selloff put the Dow below 10,000 for the first time in four years.

The Fed said it is creating a new entity to buy three-month unsecured and asset-backed commercial paper directly from eligible companies.

"The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors" have become increasingly reluctant to buy commercial paper, especially longer-dated maturities. As the market for commercial paper shrank, the Fed said rates on the longer-term debt "increased significantly," making it more expensive for companies to borrow.

The Treasury Department, which worked with the Fed on the program, said the action is "necessary to prevent substantial disruptions to the financial markets and the economy."

The Treasury will provide money to the Federal Reserve Bank of New York to support the new program, the Fed said. It did not say how much.

If a company's commercial paper is not backed by assets or other forms of security acceptable to the Fed, the company could pay an upfront fee, the central bank said.

The Fed said it hoped its effort would jolt the commercial paper market back to life.

"This facility should encourage investors to once again engage in term lending in the commercial paper market," the Fed said. That should eventually spur financial companies to lend to each other and to their customers, including consumers, the Fed said.

The Fed said it planned to stop buying commercial paper on April 30, 2009, unless the Federal Reserve board agrees to extend the program.

There was $1.61 trillion in outstanding commercial paper, seasonally adjusted, on the market as of last Wednesday, according to the most recent data from the Fed. That was down from $1.70 trillion in the previous week. Since the summer of 2007, the market has shrunk from more than $2.2 trillion.

Pressure also is growing on the Fed to reverse course and order a deep reduction in its key interest rate, now at 2 percent. Such a move would be aimed at reviving the moribund economy by encouraging consumers and businesses to boost their spending. Many predict the Fed will act on or before its next meeting on Oct. 28-29. And, some believe it could be part of a broader coordinated move with central banks in other countries.

Fed Chairman Ben Bernanke may offer clues on the Fed's next move when he speaks Tuesday afternoon on the economic outlook and developments in financial markets.

President Bush also was set to talk about the government's $700 billion bailout effort, which lets the government buy rotten mortgages and other bad debts from banks and other financial institutions. By getting these bad debts off bank's balance sheets, they might be in a better position to raise capital and more willing to lend to each other and to customers.

The Fed pledged Monday to take "additional measures as necessary" to battle the worst credit crisis in decades.

Treasury Secretary Henry Paulson has tapped a former Goldman Sachs executive to be director of the government's bailout program. Neel Kashkari, who has worked with Paulson at the department since July 2006, was chosen Monday as the interim head of the government's unprecedented effort to unclog the credit markets.

Kashkari, who was a vice president in Goldman's San Francisco office before joining the department, is one of four former executives from the firm now working feverishly to resolve the financial crisis.

The lending lockup is a key reason why the U.S. economy is faltering. Unable to borrow money freely or forced to pay a high cost to borrow, employers are cutting jobs and reducing capital investments. Consumers have retrenched.


2 Comments – Post Your Own

#1) On October 07, 2008 at 1:43 PM, XMFSinchiruna (26.40) wrote:

By Mark Felsenthal and Glenn Somerville

The U.S. Federal Reserve on Tuesday said it would begin buying the short-term debt many companies use to fund their day-to-day operations, its latest emergency move to try to restore credit flows and protect the economy.

The central bank is creating a facility to buy commercial paper because investors such as money market mutual funds have increasingly shied away from this form of corporate debt, a damaging economic development.

"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," the Fed said in announcing the program with the blessing of the U.S. Treasury.

The Treasury believes the Commercial Paper Funding Facility is necessary to prevent "substantial disruptions" to financial markets and the economy, the Fed said.

To support the facility, the Treasury will make a deposit of funds at the New York Federal Reserve Bank, with Fed officials saying the size of the deposit would be substantial.

Officials said the program, which will buy only top-rated commercial paper, would be up and running soon but probably not in a matter of days. Its size would depend on details yet to be worked out with financial market participants, Fed staff told reporters.

Of $1.75 trillion in commercial paper outstanding in August, eligible issuers accounted for $1.3 trillion. But the central bank does not intend to buy anywhere near that amount, the officials said.


The central bank's unusual move to buy debt that is not collateralized could help thaw frozen credit markets.

"It will certainly help to improve confidence in the short-term funding markets," said Derrick Wulf, a portfolio manager for Dwight Asset Management in Burlington, Vermont. "It's pretty unprecedented for a central bank to buy unsecured debt."

But some analysts worried that yet another emergency Fed buying spree, announced a scant four days after Congress approved a $700 billion (399 billion pound) financial bailout package, smacked of desperation.

"The Fed is back to 'whack a mole' again because that's the problem of the day," said Bob Andres, chief investment strategist for Portfolio Management Consultants in Philadelphia. "When you scramble, you don't instill confidence."

The U.S. stock market, which had opened higher as the Fed's announcement help calm jittery nerves on Wall Street, soon gave back those initial gains and were down in late-morning trade. Prices for U.S. Treasury bonds fell as investors held back from buying safe-haven government securities.

The dollar and yen fell as investor appetite for risk increased, and markets scaled back bets of a big Fed rate cut soon, as indicated by short-term interest rate futures.

The U.S. commercial paper market contracted dramatically for a third straight week last week, according to Fed data, as business lending and borrowing effectively shut down.

The weekly drop was the largest in at least seven years. Over a quarter of the market has disappeared since the start of the global credit crisis in the summer of 2007.


The Fed said a special-purpose vehicle will be established to buy three-month unsecured and asset-backed commercial paper directly from eligible issuers.

The Fed would buy only the highest-quality commercial paper at a spread over the three-month overnight indexed-swap rate, a measure of anticipated central bank-set interest rates. The debt would have to be secured to the Fed's satisfaction through a fee, collateral or some other means.

The Fed expressed hope that the new facility, by eliminating risk about whether eligible issuers would be able to repay investors, would encourage resumption of normal term lending in the commercial paper market.

The special purpose vehicle will stop buying commercial paper on April 30, 2009, unless the Fed decides to extend the program. But the Fed said it will keep funding the vehicle until any assets that it holds have matured.

(Additional reporting by Richard Leong in New York, Editing by Chizu Nomiyama)



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#2) On October 07, 2008 at 5:30 PM, russiangambit (28.68) wrote:

You know what Russian government did before the default of 1998? It knew it was bancrupt, so it requested loans from all major banks on conditions the banks "couldn't refuse" right before the default. So, it had at least some money to run the country and to hell with the banks.Upon the default the banks were left high and dry and even solvent ones refused to lend any money and froze all currency-denominated deposits. Financial life stopped completely for 3 days. When market reopened, USD was 600% higher against the ruble. And Russia was mostly cash economy at the time. 

I hoped never to go through something like this again.

The US government doesn't have enough money to prop up all the failing banks right now. So, it is trying to borrow from foreigners (and the major difference is that it still can) but it cannot borrow enough if the banks keep hoarding cash. The next step in this saga could be an attempt to part banks with some of their cash through back-door, by raising FDIC reserves , for example. So, that then it can pump this cash back into the system and try to create liquidity.

I know this logic probably doesn't make sense, it doesn't even make much sense to me. It is like taking money from right pocket  and putting it into the left. But I think this is a natural step in trying to break a liquidity crisis.


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