Vol 6 (2009) - Issue 1

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US Government Initiatives of 2008 that Bolster Liquidity in the Short-Term Debt Markets

The unprecedented credit crunch has severely impacted the availability of funding in the short-term debt markets. In an effort to address the illiquidity of the US short-term debt capital markets, the Board of Governors of the Federal Reserve System (the ‘Federal Reserve’) and the US Department of the Treasury (the ‘Treasury Department’) have taken innovative and aggressive steps in 2008 to restore confidence in certain short-term debt products and to bolster liquidity in the short-term markets generally.

The AMLF

On 19 September 2008, the Federal Reserve took its first decisive step to bolster liquidity in the US shortterm debt markets by establishing the Asset-Backed Commercial Paper (‘ABCP’) Money Market Mutual Fund Liquidity Facility (‘AMLF’). The Federal Reserve established the program to curb the ‘run’ on money market funds that occurred earlier that week when a number of frantic investors, fearing losses in the fall-out relating to the Lehman Brothers insolvency, withdrew their investments.

In response, the Federal Reserve quickly created the AMLF to enable it to extend loans to eligible borrowers to finance their purchases of high quality ABCP from qualifying money market mutual funds. The AMLF effectively makes the Federal Reserve a ‘lender of last resort’, enabling funds holding ABCP to meet investor redemption demands and thereby hopefully assuring investors in money market funds that cash would be on hand for redemptions, via the Federal Reserve.

Under the AMLF, eligible borrowers can borrow funds from the Federal Reserve Bank of Boston to fund the purchase of ABCP from qualifying money market mutual funds. The ABCP posted as collateral under the AMLF must be highly rated, be denominated in US dollars, mature within 270 days from the date of issuance and be issued by a US issuer in a program already in existence on 18 September 2008. The borrower must purchase the ABCP from the qualifying money market fund at acquisition cost, not market value.

The tenor of the loans available under the AMLF depends on the type of borrower. The loans generally remain outstanding until the maturity of the financed ABCP, but if the borrower is a depositary institution, the maximum term is 120 days (and the ABCP posted as collateral may not have maturities extending beyond 120 days). A loan may not be prepaid in full or in part prior to the maturity of the loan, except in the event of a bankruptcy or receivership of the borrower, and each loan has a fixed rate of interest through the life of the loan equal to the primary credit rate in effect when made (currently 0.50%).

Borrowers are incentivised to finance ABCP through the AMLF. First, there are no special fees associated with drawing under the AMLF. Secondly, the loans under the AMLF are non-recourse. Thirdly, holdings in ABCP will not be assessed a regulatory capital charge because of the non-recourse nature of the AMLF loans.

As extended on 2 December 2008, the term of the AMLF is scheduled to expire on 30 April 2009, unless further extended by the Federal Reserve.

The Temporary Guarantee Program

On Friday, 19 September 2008, as an additional Federal response to the above-referenced run on money market funds, President George W. Bush authorised the Secretary of the Treasury, Henry M. Paulson, Jr, to utilise USD 50 billion of funds to guarantee the holdings of specified money market funds on a temporary basis. On 29 September 2008, the Treasury Department released the details relating to this temporary guarantee program (the ‘Temporary Guarantee Program’).