Fed to provide a backstop for the commercial paper market

Money market mutual funds have essentially been acting like banks by effectively loaning money to commercial businesses on a short-term basis (typically 90 days or less) by buying commercial paper from them. Unfortunately, massive redemptions from money market funds and concerns about creditworthiness have led to a severe drop in demand for commercial paper by money market funds, leaving a lot of commercial businesses without an important source of credit. So, this morning the Federal Reserve announced a new program called the Commercial Paper Funding Facility (CPFF), which will be a "backstop" for the entire commercial paper market. This program will not be buying up existing commercial paper (CP), but will buy new issues of CP, especially as companies pay for their maturing CP and seek to roll it over to a new issue of CP.

Although the new program could buy up all new issues of CP, the intent is to price it a little higher than the normal market to give the normal market a chance to pick up the slack as the markets settle down so that the program will eventually be only a "backstop" when demand for CP is too low to support the available supply being created by businesses.

Although banks do sometimes issue CP (e.g., the structured investment vehicles used to finance the creation of mortgage-backed securities), it is mainly non-bank commercial businesses that depend of CP.

In any case, this is another important puzzle piece falling into place for solving the current financial crisis.

The bad news is that plenty more puzzle pieces are needed.

-- Jack Krupansky