Fed to Purchase U.S. Commercial Paper to Ease Crunch (Update1)

Oct. 7 (Bloomberg) — The Federal Reserve will create a special fund to purchase U.S. commercial paper after the credit crunch threatened to cut off a key source of funding for corporations.

The Treasury will make a deposit with the Fed’s New York district bank to help set up the special purpose vehicle. The central bank will also lend to the program at policy makers’ target rate for overnight loans between banks. The Fed Board invoked emergency powers to set up the unit, the central bank said in a statement released in Washington.

Today’s action follows a slide in the commercial-paper market to a three-year low of $1.6 trillion last week as investors fled even companies with few links to the subprime mortgage crisis. Companies from newspaper firm Gannett Co. to electricity producer Southern Co. have been forced to tap credit lines or forego raising debt because of the market’s disruption.

The Fed didn’t say how much commercial paper, which hundreds of companies use to finance payrolls and meet other cash needs, it plans to purchase.

Stocks climbed and Treasuries sank after the Fed’s announcement. Futures on the Standard & Poor’s 500 Stock Index gained 1.9 percent to 1,073.60 at 9:15 a.m. in New York. Yields on benchmark 10-year notes climbed to 3.55 percent from 3.45 percent late yesterday.

Bernanke Speech

Today’s announcement came hours before Fed Chairman Ben S. Bernanke speaks on the economic outlook at 1:15 p.m. in Washington. He and Treasury Secretary Henry Paulson held discussions yesterday as stock markets slid and money market rates climbed as the crisis deepened.

The Fed’s new unit will buy three-month dollar-denominated commercial paper at a spread over the three-month overnight- indexed swap rate, which is a measure of traders’ expectations for the Fed’s benchmark rate.

Commercial paper purchased by the vehicle must be rated at least A1/P1/F1, the Fed said. Issuers will pay the unit an upfront fee based on the commercial paper initially sold to the vehicle. The vehicle will cease buying commercial paper on April 30, 2009, unless the Board of Governors agrees to extend it.

The Fed yesterday said it will double its cash auctions to banks to as much as $900 billion, and telegraphed today’s announcement by saying it was looking for other ways to alleviate liquidity strains.

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