Commercial Paper

Release Date: October 7, 2008

For release at 9:00 a.m. EDT

The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve’s existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.

By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.

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Money Market Mutual Funds

There is a proposal along with the Resolution Trust Corporation idea for the Us government to back Money Market Mutual Funds whose value may be dropping because of the current credit crunch. Lots of people wind up putting money into money market funds between purchasing stocks with their cash. I’m sure with the recent ban on short selling stocks, that there is quite  a bit of money moving into money market mutual funds. Think of  a money market mutual fund like a normal mutual fund, but they invest in cash type investments such as CD’s.The plan would help to shore up the money market mutual funds which have falling values. Ideally Money Market Mutual Funds that are well managed are fairly safe bets in an environment with fluctuating market prices, but this announcement by the US Treasury leads to the question of whether they are really all that safe. It likely depends upon, like any other investment, the person managing the money market mutual fund.

Money Market Mutual Funds

What Is a Money Market Fund?
A money market fund is a mutual fund that invests solely in cash/cash equivalent securities, which are also often referred to as money market instruments. These investments are short-term, very liquid investments with high credit quality.

They generally include:

Certificates of deposit (CDs)
Commercial paper
U.S. Treasuries
Bankers’ acceptances
Repurchase agreements
Securities and Exchange Commission (SEC) rules dictate that the average maturity of money market fund securities must be 90 days.

Just like any other mutual fund, money market funds issue redeemable units (shares) to investors and must follow guidelines set out by the SEC. All the attributes of a mutual fund apply to a money market mutual fund, with one exception that relates to its net asset value. We’ll take an in-depth look at this exception later on.

Money Market Funds Vs. Money Market Accounts
A key difference between money market funds and money market accounts is that the former are sponsored by fund companies and carry no guarantee of principal, while the latter are interest-earning savings accounts offered by Federal Deposit Insurance Corporation-insured financial institutions with limited transaction privileges. In this case, account principal is guaranteed up to $100,000 by the FDIC. Money market accounts usually pay a higher interest rate than a passbook savings account, but generally a slightly lower interest rate than a bank certificate of deposit or the total return of a money market fund.