Fed will fund short-term business loans

October 7, 2008 6:44:31 AM PDT
The Federal Reserve has announced a plan to buy massive amounts of short-term debts in a dramatic effort to break through a credit clog that is imperiling the economy. The Federal Reserve said Tuesday it will buy "commercial paper," a short-term financing mechanism that many companies rely on to finance their day-to-day operations, such as purchasing supplies or making payrolls.

Commercial paper is a way of borrowing money for short periods, typically from overnight to less than a week. The market for this crucial financing has virtually dried up, making it increasingly difficult and expensive for companies to raise money to fund their operations.

The unstable situation has left many companies vulnerable. The notion under the plan is for the government to come up with a backstop that would provide companies with a new place to get cash. Depending on the ultimate shape of the plan, the Fed could become a source of credit for nonfinancial businesses in addition to commercial banks and investment firms.

The Fed made an opaque reference on Monday that it was exploring "ways to provide additional support" to "unsecured funding markets."

The creation of a separate legal entity was being examined as one way for the Fed to get into the commercial paper market, the person with familiar with the plan said.

The Fed pledged Monday to take "additional measures as necessary" to battle the worst credit crisis in decades. Nevertheless, stocks took a nosedive, with the Dow Jones industrials plunging more than 800 points at one point during the day before finishing down 370. Fears spread around the globe about the ability of policymakers in the United States and abroad to turn around the situation.

The lending lockup is a key reason the U.S. economy is faltering. Unable to borrow money freely or forced to pay a high cost to borrow, employers are cutting jobs and reducing capital investment. Consumers have retrenched.

To help ease credit stresses, the Fed announced Monday that it will provide as much as $900 billion in cash loans to squeezed banks. It said 28-day and 84-day cash loans being made available to banks will be boosted to $150 billion apiece. Those increases will eventually bring the amounts outstanding under the program to $600 billion.

Loans that will be made available in November to banks also will be increased to $150 billion each. That makes a total of $900 billion in credit potentially outstanding over year-end, the Fed said.

The Fed also said it will begin paying interest on commercial banks' reserves, another way to expand the central bank's resources to battle the credit crisis.


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