Fed launches second lending program to ease credit flows

WASHINGTON (AP) — The Federal Reserve on March 17 announced its second emergency lending facility in an effort to smooth the flow of credit to businesses and households struggling amid the virus outbreak.

The facility, like the previous program the Fed launched earlier March 17, is a revival of a financial-crisis era program launched in March 2008, known as the “primary dealer credit facility.”

It essentially allows a wider range of financial institutions to access short-term loans from the Fed — in this case investment banks and securities trading divisions of large banks — and allows them to pledge a wider range of collateral in return for the loans.

In the Fed’s other short-term lending programs, which were ramped up to roughly $1 trillion per week last week, banks could only use Treasury securities as collateral.

The program was first used by the Fed during the 2008 financial crisis to unclog a short-term lending market for what is known as “commercial paper.” Large businesses issue commercial paper, essentially IOUs, to raise cash to meet payrolls and cover other short-term costs.

“An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak,” the Fed said in a statement.

Borrowing rates in the commercial paper market have been spiking as more companies have sought to raise cash in the expectation that their revenue will plunge.

At the same time, money market funds, among the largest buyers of the short-term loans, are seeking to sell commercial paper themselves. They need to raise money because they expect large institutional investors to withdraw funds, and they need cash to cover those withdrawals.

All that activity has made it harder for banks and other companies to raise the cash they need.

“The goal is to prevent a larger catastrophe that includes soaring bankruptcies, unemployment and underemployment,” said Joe Brusuelas, chief economist at tax advisory firm RSM. “While we are encouraged by this policy step, the Treasury will need to step up with other funds and bridge loans” that can help companies with lower credit ratings. Only companies with top credit ratings are eligible to borrow from the Fed’s new facility.

In its announcement, the central bank said it set up the investment vehicle to buy commercial paper with the approval of the Treasury Department. The Treasury has also committed to guarantee up to $10 billion of the loans to prevent the Fed from taking losses. Companies that borrow through the facility will pay a small fee and interest.

“The economic disruption and uncertainty created by COVID-19 has created challenges for the commercial paper market, constraining access to short-term credit for American businesses,” Mnuchin said.

The Fed action comes after the central bank unleashed a massive program of stimulus March 15, when it cut its benchmark short-term interest rate to near zero and said it would purchase $700 billion in bonds. The Fed also allowed banks to lend from cash reserves that it had previously required banks to hold.

Many analysts say they expect the Fed to revive other financial-crisis-era programs in the coming days, including one known as the term auction facility, or TAF. This facility allows a wider array of banks to borrow from the Fed and to pledge a range of collateral, such as corporate bonds, rather than just Treasuries.

Updated: 
03/18/2020 - 9:08am