Summary: Today the Federal Reserve an important step necessary to stabilize the US financial system, now in a state of virtual cardiac arrest. Delay or inadequate scale of action taking additional steps will probably have unpleasant consequences.
My recommendations for our economic crisis were described in A solution to our financial crisis.
- Stabilize the financial system.
- Stabilize the economy.
- Arrange long-term financing for steps #1 and #2 with our foreign creditors.
The specifics for #1 were as follows:
(A) Broad guarantees of the securities for the financial sector. Not just banks and brokers, but also leasing companies and lenders of every flavor. Confidence in these securities must be restored now.
(B) Direct lending to business. For example,
(1) Direct loans to corporations by the Fed (e.g., Fed purchases of commercial paper from companies).
(2) Fast loans from the Small Business Administration on simple security (personal guarantees and net assets of the business). As were made to families after Katrina.
Today the Fed announced that is it doing 1 above, making direct unsecured loans to non-financial companies (e.g., buying their commercial paper). I see no alternatives at this time. This is good news, but will require massive funding to have the necessary effect.
The Fed announcement
Press release on 7 October 2008:
The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve’s existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers.
The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.
The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, 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. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.
By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.
Commercial Paper Funding Facility (CPFF) Terms and Conditions (57 KB PDF)
Afterword
If you are new to this site, please glance at the archives below. You may find answers to your questions in these, such as the causes of the present crisis. I have been writing about these events for several years; since November 2007 on this site. As you will see explained in these posts, the magnitude of the events now happening is beyond what most Americans have — or can — imagine.
Please share your comments by posting below. Please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For more information
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- about the Financial crisis – what’s happening? how will this end?.
- about The End of the Post-WWII Geopolitical Regime.
