what is commercial paper, short-term debt, will the commercial paper funding facility work
Associated Press

Fed Announces Commercial Paper Funding Facility

October 09, 2008 04:04 PM
by Anne Szustek
The Federal Reserve unveiled a plan on Tuesday to buy short-term corporate debt in a bid to keep liquidity flowing to businesses.

Commercial Paper Facility to Keep Credit from Slipping Away

The Commercial Paper Funding Facility is the latest brainchild of the Fed to keep credit markets open and allow companies to fund their operations. Once it gets up and running, the resource will draw its funding from a special purpose account. The Treasury Department will deposit funds at the Federal Reserve Bank of New York for the lending unit.

The facility is expected to buy only commercial paper that program managers deem very low risk. “Of the $1.75 trillion in commercial paper outstanding in August, eligible issuers accounted for $1.3 trillion, but the Fed has no intention to buy anywhere near that amount,” Reuters cited government officials as saying.

Commercial paper has long been the preferred method for businesses to obtain short-term financing by selling their own debt certificates. At the end of the predetermined maturity period, the debt is redeemed, often with the proceeds of a new sale of commercial paper. The debt may be unsecured or backed by assets, including mortgages, such as the bad debt the federal government plans to purchase in the $700 billion financial rescue package.

Given the tight lending market, access to credit is critical for the livelihood of businesses—and in turn, for the economy as a whole. The collapse of investment bank Lehman Brothers, which defaulted on an enormous sum of debt, caused investors to stop purchasing commercial paper. With the Fed’s new commercial paper lending facility, federal authorities hope that investors will see less risk and return to buying up this short-term corporate debt.

Despite the potentially liquidity enhancing move, interest rates on overnight commercial paper rose as much as 1 percent, signaling trepidation over the credit market nonetheless.

Opinion & Analysis: Will the Commercial Paper Funding Facility work?

With the economy as shaky as it is, the Fed is trying any device possible to keep things in balance. And investor confidence is a major factor—whether it is over the $700 billion bailout bill or the commercial paper fund. Bloomberg columnist John M. Berry thinks that getting bad debt off balance sheets and freeing up the credit markets are valid steps and could work, yet “the government still will be forced to inject capital into the institutions in exchange for some type of equity position.”

These rescue programs may take some time to take effect and quell investors’ fears. But as most commercial paper “rolls over” every 30 to 45 days, urgent action is needed. Bond market expert Anthony Crescenzi told BusinessWeek that unlike the largely mortgage-backed losses seen some 13 months ago, in the current commercial paper market, “the purge is broad and is impacting issuers with far more predictable cash flows—regular run-of-the-mill companies in need of working capital.”

Reference: Commercial paper

Commercial paper is a short-term debt vehicle issued by a company to get easy financing. They are generally considered safe investments and have minimum denominations of $100,000.

Asset-backed commercial paper is like standard commercial paper, although it is backed by securities such as mortgages or student loans. If there are adverse market trends in the securities in question, they are reflected in the interest rates for commercial paper.

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