March 18, 2020
The Federal Reserve stepped in to help the commercial paper market and overnight lending to investment banks.

Executive Summary:

The Federal Reserve (Fed) rolled out two more tools, first utilized during the Great Recession, to respond to the rapidly evolving coronavirus (COVID-19) outbreak. While such moves will not stop a recession, they can hasten recovery and restore smooth market functioning within the US fixed income arena and short-term lending, which is critical to the global economy and could help prevent further damage.

What Happened

On March 17, the Fed restarted the Commercial Paper Funding Facility (CPFF) and the Primary Dealer Credit Facility (PDCF), using the emergency powers under Section 13(3) of the Federal Reserve Act, with approval of the Treasury Secretary.

The CPFF will purchase top-tier rated unsecured and asset-backed commercial paper directly from eligible companies. Commercial paper is a short-term negotiable note maturing in less than 9 months (270 days or less) and issued by industrial, commercial, and financial companies. It is used to fund short-term operational needs of large businesses, such as accounts payable and inventories, while firms await payment.

The PDCF will offer overnight and term funding with maturities up to 90 days to primary dealers, which is the technical name for investment banks. The Fed committed to keeping the PDCF in place for at least six months using the discount rate, which is currently 0.25%. Credit extended to primary dealers under this facility may be collateralized by various investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities.

Background on Both Programs

During the Great Recession, the CPFF and PDCF were temporary programs chiefly used for a year or two. These, along with four other targeted funding facilities, were collectively known as the Fed’s alphabet soup. More importantly, their use during the Great Recession is illustrative of just how effective these programs can be in supporting proper market function during times of market stress. 

The commercial paper funding facility was established in late October 2008. In January 2009, the CPFF’s total outstanding value peaked at $350 billion in a market estimated around $1.5 trillion in size. The CPFF was closed to new lending in February 2010, and the remaining holdings matured in April 2010. All CPFF loans were repaid in full, and the program was ended in August 2010.

The bulk of the CPFF was used over a 10-month span during the deepest period of the Great Recession.

The primary dealer credit facility was established on March 16, 2008, after the collapse of Bear Stearns. It was needed since investment banks are not eligible for overnight funding directly from the Fed’s so-called discount window.

It was predominantly used during two episodes. The first big chunk was about $40 billion, most of which was direct to Bear Stearns, and approached zero within nearly four months. There was a second big spike to almost $150 billion several months later when Lehman Brothers began to wobble in mid-September. The number of firms utilizing the PDCF was never more than a dozen, and the total outstanding tapered sharply within three months and was zero in eight months. Similar to the CPFF, all loans extended under the PDCF were repaid in full with interest, and it was closed on February 1, 2010.

The PDCF was utilized in two episodes for just 15 months and by roughly a dozen firms at its peak.

Our Take

The sum of the Fed’s actions over the past 10 days amounts to a staggering level of support for the US financial system and its fixed income markets. These programs clearly demonstrate the Fed is doing whatever it takes to combat the fallout from the virus outbreak.

The stress in short-term funding markets and fixed income’s liquidity levels demanded this type of intervention—and may require more action to ensure that these markets function properly. For instance, additional asset purchases, expanded repo operations, and the CPFF appear to be helping restore some of the liquidity missing in the US fixed income markets. Last week’s sell-at-any-cost of US Treasuries due to drained liquidity appears to have subsided. However, credit spreads in corporate and municipal bonds remain very elevated, which is still causing pricing dislocations.

Moreover, the Fed’s swift and decisive actions were necessary, and we believe they have influenced other global central banks to unfurl similarly impactful monetary policy actions.

As liquidity and trading move towards more normalized levels in the US Treasury market, this should eventually help ease pressures on other areas in fixed income. Given uncertainty surrounding the impact and duration of the COVID-19 outbreak on the global economy, we suspect credit spreads will remain high.

Bottom Line

The Fed’s aggressive monetary policy measures—coupled with the anticipated fiscal stimulus expected from Congress and the White House—are necessary to address the immediate stresses in the financial system and alleviate the virus’s economic damage until the coronavirus is contained. Such moves cannot stop a recession, but could hasten the recovery and help restore smoother market functioning within US fixed income and short-term lending, which play critical roles in the global economy.


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