Fed Moves to Thaw Credit Markets

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Federal Reserve Chairman Ben Bernanke warned Tuesday that the financial crisis has not only darkened the country's current economic performance but also could prolong the pain. Video by AP

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By Neil Irwin and Steven Mufson
Washington Post Staff Writers
Tuesday, October 7, 2008; 12:31 PM

The Federal Reserve, in a bold new attempt to jump-start the lending that is the lifeblood of American business, said it will buy up the short-term debt that funds the daily operations of banks and ordinary businesses.

Using its emergency authority for the third time this year, the Fed will create a special entity that will purchase "commercial paper," the debt that companies use to fund their inventories, payrolls and other short-term cash needs. The Treasury Department will help fund the program.

Problems in the commercial paper market have been one of the most direct ways in which the financial crisis has threatened to affect the nuts and bolts economy. Banks and financial firms have become hesitant to lend, and companies have worried about raising the money needed to pay their bills.

Today's radical move by the Fed puts the central bank in the position of funding individual financial institutions and ordinary companies, even with "unsecured" debt, or that which is backed only by the company borrowing money, rather than with specific collateral.

There is no cap on the size of the program, senior Fed staffers said, other than the size of the total universe of eligible commercial paper: $1.3 trillion. Fed officials do not anticipate taking on anywhere near that much debt, but rather are hoping that private buyers of debt will feel newly confident knowing that the central bank is available as a backstop.

Critically, the Fed will buy debt that is for three-month terms. Lately, a wide variety of companies have only been able to borrow money overnight. That has put them in the precarious position of having their fates decided every evening, as lenders must again review whether to renew the loans.

By having the government ready to buy slightly longer-term debt, that source of uncertainty should be diminished, Fed staffers are hoping.

The $1.3 trillion of available commercial paper includes about $600 billion worth that is backed by collateral, such as a business's accounts receivable. The remainder includes another $600 billion issued by financial institutions that is not backed by collateral and $100 billion from non-financial companies that involves no collateral.

Companies that sell money to the Fed entity without collateral will have to pay an insurance fee to protect the government against the risk that they go under.

The Fed entity will pay interest rates that are lower than the extremely elevated rates of recent days, but still higher than what the companies could borrow at in normal times. That way, once financial conditions return to normal, the companies needing money will naturally migrate back to private markets so as to get lower borrowing costs.

The Fed program was instituted under an emergency authority it was granted during the Depression to lend to any "individual, partnership or corporation," in "unusual and exigent circumstances." It also used that authority to engineer a buyout of Bear Stearns in March and to take over insurance company American International Group in September.

With financial markets in near-meltdown, governments around the world have been scrambling to find new ways to infuse vast amounts of cash into banks and even directly to companies to help resuscitate the global financial system.


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