Federal Reserve unveils emergency loan program during coronavirus pandemic
WASHINGTON – The Federal Reserve took a series of steps on Tuesday to support the U.S. economy, first saying it would start buying a type of debt that companies issue for short-term money, and then later during the day, to establish a program loan intended to help the banks at the heart of the financial system to function properly.
Both were efforts to maintain credit to businesses and households.
Taking a page from its 2008 financial crisis handbook, the Fed said it would support the $ 1.13 trillion market for commercial paper, a key funding source used by companies to cover payroll and operations. daily. This market, used by companies like Pfizer, Royal Dominion and DuPont, began to be strained as companies rushed to fill their coffers in the face of quarantines, closed malls and empty restaurants.
Shortly thereafter, the Fed announced that it would launch a new primary trader credit facility, which will allow banks that are key intermediaries between the Fed, the Treasury Department and the broader financial system to obtain the credits. short term loans they need to buy and hold. securities, including corporate bonds.
“The facility will allow primary dealers to support the proper functioning of the market and facilitate the availability of credit to businesses and households,” the Fed said of the new program.
By supporting the commercial paper market, the Fed is trying to protect the rest of the financial system and isolate the economy as a whole, where short-term pain could turn into long-term pain if the credit crisis prevents businesses get the cash they need to operate. , forcing them to lay off workers, delay payments to suppliers and close factories.
The Fed’s program will use a special vehicle to purchase unsecured, asset-backed commercial paper from qualifying companies, according to a central bank statement. The Fed is not allowed to expose itself to substantial credit risk, so the Treasury Department will protect the Fed from $ 10 billion in losses through its Exchange Stabilization Fund.
Treasury Secretary Steven Mnuchin, speaking at a White House press conference on the virus on Tuesday, said the central bank would be able to purchase around $ 1 trillion in commercial paper “as needed “.
“We have heard loud and clear that there are liquidity issues,” Mnuchin said.
In recent days, buyers of commercial paper have disappeared and those who stayed have asked for much higher rates. The cost of funding Royal Caribbean Cruises, which has been hit hard by the coronavirus fallout, rose from an interest rate of around 2% last Thursday to over 4% on Monday, a day before the announcement of the Fed’s financing facility, according to market participants. . The utility company Exelon has also seen its financing costs rise to a similar extent, the people added.
The Fed’s program should act as an escape valve, buying higher-rated banknotes to maintain cash flow, just as it did during the 2008 financial crisis, when largely frozen credit markets. It will also buy lower-rated notes in a one-time purchase package, providing relief for the more difficult commercial paper issues.
In order to implement the program, the central bank had to declare that the economy was facing “unusual and urgent” circumstances, allowing it to use its special lending capacities under Article 13 (3) of the Federal Reserve Act.
The Fed’s decision followed radical action it took Sunday, when it cut rates to near zero and announced a program to buy back government debt and mortgage-backed securities. These purchases are also intended to alleviate tight markets, including that for Treasury securities – which had become difficult to trade, a problem because they are in many ways the backbone of the financial system.
The Fed has also eased the terms of its so-called discount window, which allows banks to get short-term loans from the Fed. He encouraged banks to start using the program and the country’s largest banks said monday night they would use the program. Regulators have also provided limited regulatory relief to banks to keep credit in circulation.
After the 2008 financial crisis, Washington forced the big banks to hold onto trillions of dollars in assets that could be easily converted into cash. Regulators told banks on Tuesday they could start selling some of those assets and encouraged them to use the money to lend to struggling businesses.
But investors were asking for more, especially as the commercial paper market stalled.
It was “obviously a positive step, obviously necessary,” said Ernie Tedeschi, political economist at Evercore ISI. “The only surprising thing is that it took them so long to do it.”
The fight to raise funds threatened to set off a chain reaction. Many companies, including Boeing, Kraft Heinz, and Hilton Worldwide, now use lines of credit. Money market funds – a major buyer of commercial paper – have stopped buying to keep money on hand in case their investors want to withdraw their money.
“For smaller and larger investors, the playbook says to generate cash in an uncertain environment,” says Peter Crane, president of Crane Data, a company that tracks money market funds. “You refuel before you even get to the toilet paper.”
On Monday, those seeking commercial paper financing were offered new loans with terms as short as a single day – a sign that investors are simply unwilling to tie up cash as the coronavirus fuels uncertainty and stops the cash flow, said a large commercial paper dealer, who spoke on condition of anonymity to discuss customer affairs.
The cash crunch in turn puts pressure on banks to keep their own money free to meet customer demand, potentially preventing them from mediating in other crucial markets and hampering trade in everything. , from treasury bills to corporate debt.
The biggest banks have agreed to make huge amounts of credit available to businesses. These commitments are usually not reflected in loan totals, but are added to other information and can be huge. With these loan commitments and other items, the balance sheets of the six largest US banks would have been $ 2.8 trillion higher at the end of last year, according to regulatory documents.
Bank executives say their institutions could handle large drawdowns on loans. The companies receiving the loans would put it back into the banking system, and if they gave the money to employees and vendors, they too would put it in bank accounts, said a senior bank official who was not authorized to s ‘express in public. And if there were temporary problems, banks could get the financing they need from the Fed discount window, added this person.
The Fed’s many interventions – which also include daily efforts to keep day-to-day lending between banks and financial institutions running smoothly – seem to be helping. But some analysts and investors have said further relief may still be needed.
“It’s on the mend,” said Gennadiy Goldberg, rate strategist at TD Securities, who said funding conditions and Treasury debt markets were still volatile on Tuesday. “But it’s not healed yet.”
And other problems may arise soon. If companies struggle to find buyers for their bonds at affordable interest rates in the coming weeks, the Fed could be under pressure to buy corporate bonds – which it does. not the legal latitude to do it alone, as she cannot take much credit risk. The nearly $ 10,000 billion corporate bond market overshadows the $ 1,000 billion commercial paper market.
According to economists, the fact that the new commercial paper program is backed by the source of funding from the Treasury, unlike the 2008 version, however, opens up other possibilities. The Treasury’s Exchange Stabilization Fund still has about $ 80 billion that could be mobilized.
The Treasury could use it to support other Fed facilities “to provide broader support to the economy, especially struggling small businesses,” JP Morgan’s Michael Feroli wrote in a research note. The “important thing” is that it “expands the options available to the Fed to support the economy.”
A Fed official was open to such an idea.
“Maybe,” said Patrick Harker, chairman of the Federal Reserve Bank of Philadelphia, when asked about the possibility of future Treasury-backed emergency programs. “Support for small and medium-sized businesses is something we could think of doing. “
While the Fed Council in Washington decides these issues, it does so in consultation with regional leaders.
Alan Rappeport has contributed reporting from Washington and Emily Flitter from New York.