The Fed did the same thing during the Great Recession and ended up purchasing about $350 billion worth of these loans, or about 20 percent of this market.
After the markets closed on Tuesday, the Fed announced one more backstop for the credit markets: Loans for so-called “primary dealers” that buy U.S. government bonds directly from the U.S. Treasury. These key players help ensure the smooth functioning of bond markets and will play a critical role as the U.S. government issues debt in the coming months to fund massive stimulus efforts, potentially including $1,000 checks for every American.
Taken together, these Fed actions help ensure there is a financial lifeline for businesses and households that need loans in the coming months to make it through this crisis. The commercial paper market directly impacts the mortgage and auto loan markets in addition to credit for small and large businesses.
“By ensuring the smooth functioning of this market, particularly in times of strain, the Federal Reserve is providing credit that will support families, businesses, and jobs across the economy,” the central bank said in a statement.
Wall Street investors and economists have been calling for the central bank to do this as the commercial paper market has nearly frozen in recent days. The action is known formally as a “Commercial Paper Funding Facility," and it helps prevent short-term cash crunches.
“The [Fed’s] goal is to prevent a larger catastrophe that includes soaring bankruptcies, unemployment and underemployment,” wrote Joseph Brusuelas, an economist at audit firm RSM, in a note to clients.
But Brusuelas warned that more dramatic steps might be needed. The Fed is largely restricted to buying the debt of high quality firms who are the least likely to default, but the U.S. Treasury could offer bridge loans to a wider array of firms.
The Fed has taken a series of dramatic steps this month to stabilize markets and boost the economy. On Sunday, the Fed slashed interest rates to zero and re-started a massive bond buying program to purchase $700 billion worth of U.S. Treasuries and mortgage-backed securities.
Fed Chair Jerome H. Powell, a frequent target of President Trump’s criticism, has vowed to use “our full range of tools” to revive the economy.
The U.S. Treasury authorized $10 billion to backstop the Fed from any losses as it begins to make the purchases. There were no losses during the Great Recession when the Fed did this because companies either re-paid their loans or the Fed was able to sell the loans back into the market after the panic subsided.
Treasury Secretary Steven Mnuchin immediately announced his support and said the Fed’s new fund could backstop up to $1 trillion worth of these short-term loans.
“I have just sent Chairman Jerome Powell a letter confirming that I approve the establishment of the CPFF to provide liquidity to the financial system,” Mnuchin said. “By providing short-term credit, the CPFF will help American businesses manage their finances through this challenging period.”