Fed Creates Commercial Paper-buying Facility

WASHINGTON(Reuters) – The Federal Reserve on Tuesday announced it would create aspecial-purpose facility, with the Treasury Department’s blessing, tobegin buying commercial paper in yet another emergency move aimed atcalming chaotic financial markets.

The central bank said it was acting because money market mutualfunds and other investors have become increasingly reluctant to buycommercial paper, which is widely issued to provide vital funds forday-to-day business operations at many companies.

"The volume of outstanding commercial paper has shrunk, interestrates on longer term commercial paper have increased significantly, andan increasingly high percentage of outstanding paper must now berefinanced each day," the Fed said.

Treasury believes the facility is necessary to prevent "substantialdisruptions" to the financial markets and the economy, the Fed said ina statement.

Treasury will make a deposit of funds at the New York Fed to supportthe facility, though the Fed did not specify the size of the deposit.

The central bank’s unusual move, with Treasury backing, to buy debtthat is not collateralized might help thaw frozen credit markets, ananalyst said.

"It will certainly help to improve confidence in the short-termfunding markets," said Derrick Wulf, a portfolio manager for DwightAsset Management in Burlington, Vt. "It’s pretty unprecedented for acentral bank to buy unsecured debt."

The facility gave a surge of relief to shell-shocked investors asthe trading day began on the U.S. stock market. Stock indexes jumpedand the dollar strengthened against the yen and euro on theannouncement. Treasury bonds fell sharply and interest rate futuresmarkets scaled back bets of a big Fed rate cut soon.

The U.S. commercial paper market contracted dramatically for a thirdstraight week last week, according to Fed data, as business lending andborrowing effectively shut down.

The weekly drop was the largest in at least seven years. Over aquarter of the market has disappeared since the start of the global credit crisis in the summer of 2007.

The Fed said its new commercial paper funding facility (CPFF) wouldact as a liquidity backstop for U.S. issuers of commercial paper. A newspecial-purpose vehicle (SPV) will be established to buy three-monthunsecured and asset-backed commercial paper directly from eligibleissuers.

The Fed expressed the hope that by eliminating risk about whethereligible issuers would be able to repay investors, the new facilitywould encourage resumption of normal term lending in the commercialpaper market.

The SPV will stop buying commercial paper on April 30, 2009 unlessthe Fed decides to extend that date. But the Fed said it will keepfunding the vehicle until any assets that it holds have matured.

(Editing by Chizu Nomiyama)