Fed becomes ‘lender of last resort’
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The Federal Reserve reached into it financial toolbox yet again, this time to shore up the $1.6 trillion commercial paper market. Those are short term loans that companies take out to cover their immediate need for cash, to pay workers or buy supplies, for example. To make these loans to businesses, the Fed is dipping into rare emergency powers that haven’t been used since the 1930s. John Dimsdale reports.
John Dimsdale: Over 1,700 businesses use commercial paper loans. But the market has shrunk by about $150 billion in the last few weeks as lenders worry that credit-squeezed companies won’t pay them back. So the Fed announced it will make loans for three months to eligible companies.
During a speech to economists in Washington today, Fed chairman Ben Bernanke said the move is designed to unfreeze credit markets.
Ben Bernanke: The expansion of federal reserve lending is helping financial firms cope with reduced access to their usual sources of funding.
In some cases, the Fed will not require collateral, although borrowers will pay up-front fees. Bob Reed, an analyst with the B-net business Web site, says the Fed is betting that money will begin to flow again.
Bernanke is taking a gamble here that says, look, I need to restore confidence not only to the economy as a whole, but specifically to the credit market which has been tightening so dramatically over the last couple of weeks. So, he’s trying to send a signal to lenders and borrowers that the government will back up their play.
The Fed essentially has unlimited resources to make commercial paper loans. But if companies don’t pay back, the federal deficit swells and interest rates rise. Villanova University Professor Victor Li says the Fed finds itself in an uncomfortable position.
This is really something that the Fed doesn’t typically do. They can intervene in this way, but typically they would rather have financial markets work themselves out in terms of the commercial paper aspect of the market.
Credit markets eased a bit after the Fed’s move on hopes the government loans will relieve a cash shortage for many companies.
In Washington, I’m John Dimsdale for Marketplace.
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