US Seeks To Thaw Markets With Aid For Money Market Funds - Report

Tom Burroughes

22 October 2008

The US Federal Reserve said it would finance up to $540 billion in purchases of short-term debt from money market mutual funds to shore up a key pillar of the US financial system, according to the Financial Times.

Money market funds have faced severe redemption pressures since the financial crisis deepened last month, forcing them to raise cash by scaling back their short-term lending to banks and selling their holdings of commercial paper.

This retreat has contributed both to a freeze in the interbank market and a steep decline in activity in the commercial paper market, which has made it difficult for banks and companies to raise short-term funds.

“The short-term debt markets have been under considerable stress in recent weeks as money market mutual funds and other investors have had difficulty selling assets to satisfy redemption requests and meet portfolio rebalancing needs,” the Fed said.

Under the scheme the US central bank will lend money to five special purpose vehicles, to be managed by JPMorgan, tasked with purchasing assets from money market funds. These assets are low-risk paper, including certificates of deposit, bank notes and commercial paper with three-month maturities or less.

The creation of an extra liquidity facility was seen as complementing a move the Fed announced two weeks ago to create a vehicle aimed at purchasing potentially unlimited amounts of three-month debt from banks and non-financial companies. The size of the Fed’s balance sheet has nearly doubled.

Each of the five vehicles may purchase paper from 10 financial institutions. The overall size of the programme is capped at $600bn – with the Fed funding 90 per cent and the funds, which sell assets, taking the first 10 per cent of losses.