WASHINGTON — Despite signs of strength in the credit markets, the Federal Reserve Board on Tuesday unveiled a new program to provide more liquidity to money market mutual funds.
If that sounds familiar, it should. It is the Fed's second attempt in a month to bolster money market funds. The first program targeted asset-backed commercial paper held by the funds. Now the central bank plans to tackle the unsecured commercial paper they hold. The Fed has a third program set to launch Monday that will purchase commercial paper — both secured and unsecured — from any U.S. issuer.
Observers said the moves are all designed to provide market players with enough comfort to resume lending.
"It's allaying the liquidity fears that are preventing lenders from extending out on the curve, and that's really the issue," said Lou Crandall, the chief economist at Wrightson ICAP. "If you give them an absolute solid secondary market guarantee, it allows them to extend out on the curve."
The Fed is reacting to fallout caused by Reserve Primary Fund, a major money market fund, which "broke the buck" last month and sparked a wave of withdrawals at other funds.
As these funds hoarded cash, they stopped buying bank debt, and that led to banks pulling back from their borrowers. With this latest program the Fed is trying to break that cycle and get money flowing again.
The Fed's latest program, the Money Market Investor Funding Facility, will consist of five funds that will be run by JPMorgan Chase & Co.
The central bank will provide up to $540 billion, and JPMorgan Chase's five funds, in turn, will purchase from money market funds certificates of deposit, bank notes, and commercial paper with remaining maturities of 90 days or less.
The Fed said it will decide the program's start date this week; it is scheduled to end on April 30.
The Fed's three programs — last month's money market backstop, the commercial paper plan, and Tuesday's program — are interconnected. The initial money market backstop was designed to help investors while the commercial paper plan was a lifeline for issuers of debt. But the commercial paper facility created an inequity because it purchased unsecured debt while the money market program only bought asset-backed commercial paper. Tuesday's program bridges that gap by expanding the Fed's reach into unsecured assets held by the money market funds.
As with its prior efforts, the Fed says it is taking steps it hopes will minimize taxpayer risk. Debt purchased must have short-term ratings of A-1/P-1/F1 from two or more rating agencies. The Fed has also hedged some of the risk by paying only 90% of the amount the funds will pay for the debt. The remaining amount would be paid in the form of asset-backed commercial paper, which will absorb the first losses. Senior Fed officials told reporters Tuesday that JPMorgan Chase was selected to run the program by the participating money market funds.
JPMorgan Chase will receive fees that will be funded by a portion of the net interest income generated by the conduits. The Fed would not detail how the payments would be structured.
Though the program should help bank funding, some observers said it could create unintended consequences, such as shifting deposits away from the banking system.
Chris Low, the chief economist at First Horizon National Corp.'s FTN Capital Financial, said money market funds have lost $500 billion since Lehman Brothers filed for bankruptcy last month. That loss translated into a gain at many banks, he said, in the form of deposits. But that trend could now reverse.
"The immediate threat to banks from this program is one of the intentions is to pull deposits out of the banks and back into money markets," he said. "If investors can be reassured that money markets are safe again, they're likely to go back in that direction."
Still, some industry representatives said they supported the program.
"That makes funds available to all aspects of the commercial paper market," said Scott Talbott, the senior vice president of government relations at the Financial Services Roundtable. "It restores us to the system we had before."
