Going forward, with money market mutual funds in need of liquidity we may also see the return of AMLF and MMIFF, while the need for overnight funding by primary dealers could be met by PDCF. An extension of USD liquidity swap line arrangements with a wider set of central banks may also be necessary. And if the stigma attached to the discount window remains a problem, we could also see the return of TAF.
Introduction
Markets were screaming for it, but finally today the Fed relaunched the Commercial Paper Funding Facility (CPFF) in order to deal with the freezing up of the US commercial paper market. At present, the coronavirus outbreak is hitting the cashflow of businesses, who therefore need to raise cash. At the same time, the money market mutual funds – the regular buyers of commercial paper – are also trying to raise cash in anticipation of outflows from the MMMFs by investors. In other words, the commercial paper market had increasingly become dysfunctional. The reintroduction of the CPFF brings in the Fed as a large buyer of commercial paper and should help stabilize the market.
How does it work?
Through this facility the Fed finances a special purpose vehicle (SPV) that purchases 3 month commercial paper from eligible users. In this way the Fed takes over the role of money market mutual funds and other buyers of commercial paper that stopped purchasing in recent days. This also reduces the pressure on banks providing credit to issuers unable to sell commercial paper anymore. By providing a liquidity backstop for issuers of commercial paper the Fed hopes to stabilize the commercial paper market. Note that through this channel the Fed is also able to provide liquidity to businesses, not only depository institutions which already have access to the Fed's discount window.
Technicalities
The CPFF2020 will be structured as a credit facility to an SPV authorized under section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary. The New York Fed will commit to lend to the SPV on a recourse basis and will be secured by all the assets of the SPV. The US Treasury Department will provide $10bn of credit protection to the New York Fed in connection with the CPFF, using the Exchange Stabilization Fund.
The SPV will purchase 3 month USD denominated commercial paper (including asset-backed commercial paper) from eligible issuers through the New York Fed's primary dealers. Eligible users are US issuers of commercial paper, including those with a foreign parent company. The SPV will only purchase paper that is rated at least A-1/P-1/F-1.
There is a limit per issuer to the amount the SPV may own at any time, which is the maximum amount of USD denominated commercial paper the issuer had outstanding on any day between March 16, 2019 and March 16, 2020.
Pricing will be based on the then-current 3 month overnight index swap rate plus 200 bps.
The SPV will cease purchasing commercial paper on March 17, 2021, unless the Board extends the facility.
Why did it take so long?
In recent days markets were screaming for CPFF. Why wasn't CPFF included in Sunday's emergency package when the Fed cut rates to zero, launched a new large scale asset purchase program, and set the discount window and USD swap lines wide open? It looks like post-crisis legislation, in particular the Dodd-Frank Act of 2010, has made it more difficult for the Fed to invoke section 13(3) of the Federal Reserve Act, which is a 'unusual and exigent circumstances' clause. In particular, the Fed needs the approval from the US Treasury Secretary. Today, Mnuchin sent a letter to Powell giving him permission to start CPFF2020. It seems that Congress has tied the Fed's hands and this has not been beneficial to market functioning as we found out in recent days. Perhaps something to reconsider once this crisis is over.
What's next?
In our FOMC Preview Crash to zero, published last Thursday, we said that the Fed might soon reach for liquidity tools they used during the financial crisis. Three special lending facilities we explicitly mentioned were the Commercial Paper Funding Facility (CPFF), the Money Market Investor Funding Facility (MMIFF) and the Primary Dealer Credit Facility (PDCF). The first was relaunched today.
The second (MMIFF) was designed to provide liquidity for money market mutual funds, stimulating them to extend the term of their money market investments. Instead of scrambling for overnight assets because of liquidity fears, this would help maintain demand for term securities in the money market. Although no loans were made under the MMIFF, the facility could be useful this time. While CPFF helps issuers of commercial paper, money market mutual funds are still in need of liquidity. A related facility, which peaked at $140bn in 2008, was the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) which provided funding for depository institutions purchasing asset-backed commercial paper from money market mutual funds. The third (PDCF) would provide overnight funding to primary dealers, similar to the way the discount window provides a backup source of funding for depository institutions.
Another facility we would like to mention is the Term Auction Facility (TAF), which is basically a discount window without the stigma. On Sunday, the Fed tried to make the discount window more attractive by slashing the primary credit rate to 0.25% and encouraging banks to use the discount window, but if these incentives would fail to get banks to the discount window – because of the stigma attached to it – then relaunching TAF could help alleviate bank funding strains. In fact, today Loretta Mester (Cleveland Fed) mentioned TAF in addition to CPFF.
We also discussed a special lending facility that never went away: the USD liquidity swap line arrangements with 5 other central banks: the Bank of Canada, the Bank of England, the ECB, the Bank of Japan and the Swiss National Bank. In our view, the Fed could make its dollar liquidity swap lines available to a wider set of central banks if necessary.
And as we have argued before, the sooner the Fed introduces a standing repo facility the better.
For now, the Fed will have to adjust its repo operations on a daily basis. Besides these liquidity tools, the Fed still has room to expand its large scale asset purchase program and it could also hold down longer-term rates by strengthening its forward guidance on the target range for the federal funds rate.
All in all, the Fed is not done yet.
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