Fed to launch commercial paper finance facility amid coronavirus uncertainty
The Federal Reserve has said it will start lending to U.S. businesses, relaunching a crisis tool to help calm short-term debt markets that have faced mounting tensions in recent days.
The Fed focused on Tuesday on the dysfunctional market of $ 1.1 trillion in short-term IOUs known as commercial paper. Companies use commercial paper to finance their day-to-day business operations such as personnel costs.
While the Fed cannot buy corporate debt or lend directly to households and businesses, it can invoke emergency powers to establish lending facilities which, in turn, extend credit.
The steps show how the Fed is reorienting its tools from the 2008 crisis to tackle an ongoing economic emergency that is entirely different. At the time, concerns about the creditworthiness of major financial institutions spawned a crisis that fueled a wider economic contraction.
Treasury Secretary Steven Mnuchin said the Trump administration supports a plan to send checks to Americans, likely within the next two weeks, to ease household and business disruptions caused by the spread of the novel coronavirus. Photo: Evan Vucci / Associated Press
Now the problems are in the economy, which needs the financial system and the government to restrain businesses and households forced to curl up to prevent the Coronavirus pandemic overload local health systems.
“What economic policy can do here is create a safety net for the economy, and in particular for individuals and businesses that don’t have buffers, who aren’t able to absorb losses. lost wages or income, ”said Nathan Sheets, a former senior Treasury Department and Fed official who is now chief economist at investment advisory firm PGIM Fixed Income.
Uncertainty everywhere complicates this task: over the duration and severity of the economic downturn; on the capacity of the regulatory system to manage abrupt deleveraging; and how financial firms will operate with remote operations and alternative working arrangements.
“The problem in trying to make a distinction between economic and financial crises is that it ignores the fact that the real economy and the financial sector are inextricably linked, and therefore there is no way to have a seizure in one without it immediately causing a seizure. in the other, ”said Joshua Shapiro of consulting firm MFR Inc.
By launching the Commercial Paper Finance Facility, the Fed is trying to encourage investors to return to this market to ensure that eligible issuers can roll over their maturing bonds. The central bank facility will buy three-month debt from companies with high credit ratings. The Fed deployed a version of the tool between 2008 and 2010, during and after the financial crisis.
“The Fed is trying to break the loop for fear that companies will lose access to markets in the short term by committing that funding exists,” said Alexandra Wilson-Elizondo, senior credit portfolio manager at MacKay Shields . “It’s a symbol. A healthy commercial paper market gives businesses confidence in the futures market. “
Investors who buy longer-term debt securities measure the pulse of the short-term funding markets to gauge risk. Analysts and asset managers were alarmed to see disruptions on commercial paper, which yielded higher than some long-term bonds. This meant that the companies were in desperate need of cash or that the buyers were gone. If short-term debt instruments are struggling, it could be a sign of a difficult time ahead.
As an example of restored faith and a well-functioning, high-quality credit market,
Exxon Mobil Corp.
XOM -0.32%
on Tuesday issued loans with different maturities, borrowing at a rate of around 4% on a 30-year bond.
Tuesday’s announcement marked the Fed’s first effort in the current crisis that has required consultation with the Treasury Department, potentially opening the door to further joint ventures between fiscal and monetary authorities.
To create the latest facility, the Fed had to invoke special powers under “unusual and urgent circumstances” to authorize one of its reserve banks, the New York Fed, to extend credit. In 2010, Congress asked the Fed to seek approval from the Secretary of the Treasury before using these so-called 13 (3) powers, named after the section of its charter that allows it to set up such programs of last resort.
Treasury Secretary Steven Mnuchin approved the program on Tuesday. The Treasury will also provide $ 10 billion from its exchange stabilization fund, which has around $ 94 billion, to cover the Fed’s credit losses.
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Later on Tuesday, the Fed announced another 13 (3) loan program that will allow 24 major financial institutions known as primary dealers, which function as the Fed’s exclusive counterparties when trading financial markets, look for loans with a term of up to 90 days.
The primary brokerage credit facility will essentially function as an overnight lending facility for primary traders, in the same way that the Fed’s discount window provides a 24-hour back-up source of funding for banks. It represents the Fed’s latest attempt to unclog financial markets.
The facility will offer terms as generous as those made available in fall 2008. Primary traders will be able to pledge a wider range of collateral than the government-backed debt required for open market operations, and the Fed will charge the same. 0.25. % Rate made available to banks at the discount window.
The commercial paper market has been tight as money market mutual funds and other investors seek to sell commercial paper as demand for short-term debt increases from companies facing financial needs. unforeseen funding related to viruses.
The Fed said it would lend to commercial paper issuers at a rate of 2 percentage points above overnight lending rates for three months at a time. The installation will take at least a year.
“The conditions are not easy,” said Julia Coronado, former Fed economist and founder of economic consultancy MacroPolicy Perspectives. “It was a slight disappointment for the market.”
The installation differs from the 2008 version on an important point. While both are only open to companies with good credit ratings, the new facility will also allow companies that currently have good credit ratings but whose ratings are then downgraded by one level to access the facility. .
In 2008, it took three weeks to launch the facility, and this change could give companies greater confidence in their ability to access credit even if their ratings are downgraded before the facility is fully operational.
Tuesday’s announcement is an example of how policymakers in the days and weeks to come may need to reuse old tools and invent new ones to address the shortage of working capital in small and medium-sized businesses. and self-employed workers.
Michael Feroli, chief US economist at JPMorgan Chase, said a possible scheme would allow the Fed to provide non-recourse financing for loans taken by banks to small and medium-sized businesses at the Fed’s primary lending rate, 0 , 25%.
These loans could be limited to companies that had a good credit rating at the start of the year, to avoid lending to companies that were in difficulty before the virus hit. Relying on the banking system could reduce the administrative burden on the central bank or the Treasury associated with underwriting tens of thousands of borrowers.
The Fed has acted over the past two weeks to deal with growing market tensions at a rate that surprised veterans of the 2008 crisis, which unfolded over several months.
On March 3, the central bank approved an emergency cut to its benchmark federal funds rate by half a percentage point. Sunday he cut the rate by a full percentage point, close to zero.
The Fed also announced plans to buy $ 500 billion in treasury securities and $ 200 billion in mortgage bonds to stop funding strains in critical public debt markets, which are typically havens during a crisis. . And he promised to offer unlimited amounts of short-term loans to the big banks that are backed by government securities.
—Julia-Ambra Verlaine contributed to this article.
Write to Nick Timiraos at nick.timiraos@wsj.com
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