Fed Unveils Emergency Lending Programs as Companies Struggle to Raise Cash

WASHINGTON — The Federal Reserve took a series of steps on Tuesday to prop up the American economy, saying first that it would begin buying up a type of debt that companies issue for short-term cash and then, later in the day, establishing a lending program meant to help the banks at the core of the financial system function smoothly.

Both were efforts to keep credit flowing to businesses and households.

Taking a page from its 2008 financial crisis playbook, the Fed said it would backstop the $1.13 trillion market for commercial paper, a key funding source used by companies to cover payroll and day-to-day operations. That market, used by firms like Pfizer, Royal Dominion and DuPont, has started to come under strain as businesses raced to fill up their coffers in the face of quarantines, shuttered shopping centers and empty restaurants.

Not long after, the Fed said it would roll out a new Primary Dealers Credit Facility, which will allow banks that are key conduits between the Fed, Treasury Department and the broader financial system to get the short-term loans they need to buy and hold securities including corporate bonds.

“The facility will allow primary dealers to support smooth market functioning and facilitate the availability of credit to businesses and households,” the Fed said of the new program.

In backstopping the commercial paper market, the Fed is trying to protect the rest of the financial system and insulate the broader economy, where short-term pain could turn into long-term suffering if credit crunches prevent companies from obtaining the cash they need to function, forcing them to lay off workers, delay payments to vendors and shutter plants.

The Fed program will use a special vehicle to buy unsecured and asset-backed commercial paper from eligible companies, according to a statement by the central bank. The Fed is not allowed to expose itself to substantial credit risk, so the Treasury Department will protect the Fed against $10 billion worth of losses through its Exchange Stabilization Fund.

Treasury Secretary Steven Mnuchin, speaking on Tuesday at a White House news conference on the virus, said the central bank would be able to buy about $1 trillion worth of commercial paper “as needed.”

“We heard loud and clear there were liquidity issues,” Mr. Mnuchin said.

In recent days, buyers of commercial paper disappeared, and the ones who stayed demanded much higher rates. The funding cost for Royal Caribbean Cruises, which has been hit hard by the coronavirus fallout, skyrocketed from a roughly 2 percent interest rate last Thursday to more than 4 percent on Monday, a day before the Fed’s funding facility was announced, according to market participants. The utility company Exelon has also had its financing costs rise by a similar degree, those people added.

The Fed’s program should act like an escape valve, snapping up higher-rated notes to keep cash flowing, much as it did during the 2008 financial crisis, when credit markets largely froze. It will also buy lower-rated notes in a set of one-time purchases, offering relief for the most embattled commercial paper issues.

In order to set up the program, the central bank needed to declare that the economy faces “unusual and exigent” circumstances, allowing it to use its special lending abilities under section 13(3) of the Federal Reserve Act.

The Fed’s move followed sweeping action it took on Sunday, when it slashed rates nearly to zero and announced a program to buy up government debt and mortgage-backed securities. Those purchases are also meant to ease strained markets, including that for Treasury securities — which had become hard to trade, a problem because they are in many ways the backbone of the financial system.

The Fed has also sweetened the terms of its so-called discount window, which allows banks to tap short-term loans from the Fed. It has encouraged banks to begin using the program and the nation’s biggest banks said on Monday night they would use the program. Regulators have also been providing limited regulatory relief to banks to keep credit flowing.

After the 2008 financial crisis, Washington forced big banks to hold on to trillions of dollars in assets that could easily be converted into cash. On Tuesday, regulators told the banks they could start to sell off some of those assets and encouraged them to use the cash to lend to struggling businesses.

But investors were clamoring for more, especially as the commercial paper market seized up.

It was “obviously a positive step, obviously necessary,” said Ernie Tedeschi, policy economist at Evercore ISI. “The only surprising thing is that it took them this long to do it.”

The struggle to raise cash has threatened to set off a chain reaction. Many companies, including Boeing, Kraft Heinz, and Hilton Worldwide, are now drawing on lines of credit. Money market funds — a major buyer of commercial paper — have stopped buying to keep cash on hand in case their investors want to withdraw their money.

“For the smallest and biggest investors, the playbook says build cash in an uncertain environment,” says Peter Crane, president of Crane Data, a company that tracks money market funds. “You stock up on that even before you get to the toilet paper.”

On Monday, those seeking commercial paper funding were being offered new loans with terms as short as a single day — a sign that investors are simply not willing to tie their cash up as the coronavirus stokes uncertainty and arrests cash flow, said one large commercial paper dealer, who spoke on the condition of anonymity to discuss client matters.

The cash clamor is in turn putting pressure on banks to keep their own money free to meet customer demand, potentially preventing them from serving as an intermediary in other crucial markets and hampering trading in everything from Treasurys to corporate debt.

The largest banks have agreed to make huge amounts of credit available to companies. These commitments are typically not reflected in loan totals but are tacked on to other disclosures — and can be enormous. With these loan commitments and other items, the balance sheets of the six biggest U.S. banks would have been a combined $2.8 trillion larger at the end of last year, according to regulatory filings.

Executives at the banks say their institutions could handle big loan drawdowns. The companies receiving the loans would put it back in the banking system, and if they pay the cash out to employees and suppliers, they too would put it in bank accounts, said one senior bank executive who was not authorized to speak publicly. And if there were temporary problems, the banks could get the funding they need at the Fed’s discount window, this person added.

The Fed’s many interventions — which also include daily efforts to keep overnight lending between banks and financial institutions functioning smoothly — seem to be helping. But some analysts and investors said that additional relief may still be needed.

“It’s on the mend,” said Gennadiy Goldberg, a rates strategist at TD Securities, who said conditions in funding and Treasury debt markets were still choppy on Tuesday. “But it’s not healed yet.”

And more problems could soon arise. If companies struggle to find buyers for their bonds at affordable interest rates in coming weeks, pressure may build on the Fed to buy corporate bonds — which it lacks the legal leeway to do alone, since it cannot take on much credit risk. The nearly $10 trillion corporate bond market dwarfs the $1 trillion commercial paper market.

Economists said the fact that the new commercial paper program was backed by the Treasury funding source, unlike the 2008 version, opens up other possibilities, however. The Treasury’s Exchange Stabilization Fund still has about $80 billion that could be leveraged.

Treasury could use it to back other Fed facilities “to provide broader support to the economy, particularly toward challenged small businesses,” Michael Feroli at J.P. Morgan wrote in a research note. The “important thing” is that it “expands the options available for the Fed to support the economy.”

A Fed official sounded open to such an idea.

“Possibly,” Patrick Harker, president of the Federal Reserve Bank of Philadelphia, said when asked about the chance of future Treasury-backed emergency programs. “Supports for small- and medium-sized business, that’s something we could think of doing.”

While the Fed’s Board in Washington decides on such matters, it does so in consultation with regional leaders.

Alan Rappeport contributed reporting from Washington, and Emily Flitter from New York.