The Federal Reserve Board agreed Tuesday to buy an unlimited amount of commercial paper directly from cash-strapped companies, and rather than criticize it for becoming the lender of last resort to yet another group of borrowers, most observers simply applauded.
"In this instance we've seen the Fed try to get ahead of the curve," said Ernest Patrikis, a partner in Pillsbury Winthrop Shaw Pittman and a former lawyer at the Federal Reserve Bank of New York. "It's certainly unique. It's creative. It's the Fed saying, in effect, it will deal directly with issuers. It's a bold step."
Mark Zandi, the chief economist and a co-founder of Moody's Economy.com Inc., also used the words "creative" and "bold."
The move "stretches further the Federal Reserve's policy boundaries, and I think it should have a measurable and positive impact on the commercial paper and money markets," he said.
William Schwartz, an analyst at DBRS Ltd., agreed.
"We're in essentially full-blown crisis mode at this point, and the reality is, we have imperfect solutions to very serious problems," Mr. Schwartz said. "But I do think, in terms of being another link in the chain of liquidity moves, it will help produce a flow of credit in a market that has mostly seized up."
Since December, the Fed has created four programs to improve liquidity, including cash and Treasury auctions, loans to investment banks, and aid to money market mutual funds.
The new program is expected to be up and running within days to help businesses having trouble renewing short-term debt.
"In a sense this is a smaller problem because the assets are not as mispriced as mortgage markets have become, but it's also a much easier problem to solve than the frozen mortgage market, and it should have a much more immediate payoff," said Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial.
Fed Chairman Ben Bernanke explained the move in a speech Tuesday.
"Disruptions in the commercial paper market and tightening of bank lending standards have made it more difficult for businesses to obtain the working capital they need to meet everyday operating expenses such as payrolls and inventories," Mr. Bernanke said.
Under its program, the Fed will create a vehicle to buy three-month unsecured and asset-backed commercial paper directly from issuers.
It will be funded in large part by a deposit the Treasury Department was to make at the Federal Reserve Bank of New York, but the government did not say how much is being pledged.
The Fed said the program would also be paid for through fees charged to borrowers, but it did not explain how the fees would be determined.
To participate, an issuer must either pay an up-front fee, provide an endorsement or guarantee of its obligations, or provide collateral or another satisfactory security.
The maximum amount a single issuer may sell to the Fed would be based on its average amount of commercial paper in August 2008, minus any outstanding amount held by investors.
On Oct. 1, $1.6 trillion of commercial paper was outstanding, down from $1.8 trillion at Sept. 3.
The Fed said the market has come under strain in recent weeks as money market funds and other investors have become reluctant to buy the paper, especially at longer-term maturities.
"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," the Fed said.
Analysts said the Fed's move will let this frozen commercial credit be refinanced and the supply shored up.
"Restoring the credibility of money-market funds should go a long way toward lifting confidence in the broader stock markets," said Jack Ablin, the chief investment officer at Bank of Montreal's Harris Private Bank.
This is not to say there are no critics.
Lou Crandall, the chief economist at Wrightson ICAP, said the Fed is only addressing demand for funds — not supply.
"They are addressing the problems on the demand side of the market, but this is not necessarily going to get private suppliers of funds to move to longer maturities on the yield curve," he said.
Joseph Mason, a professor at Louisiana State University and a former economist at the Office of the Comptroller of the Currency, agreed.
"Replacing the market with a government source of funds or a quasi-government source of funds is not the same as restoring the market function, so like all these operations, this is another very short fix that will not forestall any kind of crisis down the road," he said. "It just gives us time to craft real reforms."
The program is to expire April 30, but the Fed could extend the deadline, and any observers expect it will just as the agency has done with wider access to the discount window.
"All of these programs have end dates on them … , but they are not going to stick to those dates if the system hasn't stabilized," said FTN Financial's Mr. Low, "so I think it's pretty unlikely they are going to get to extricate themselves that quickly."
"You are going to have a number of factors into when it closes, including when the system functions and acts on its own," said Oliver Ireland, a partner in Morrison & Foerster LLP and a former Fed official. "As the markets regain confidence and private parties will start to deal with each other again and become increasingly willing to accept counterparty risk, I think the Fed will remove from that role."
Gil Schwartz, a partner in Schwartz & Ballen LLP and a former Fed lawyer, said he doubted this would be a permanent move.
"I don't think this is the nationalization of the commercial paper markets," he said. "I think this is a short-term problem that, until confidence is restored, the Fed['s] stepping in is to be expected."