Bernanke opens door to Fed cutting rates

Banks, too, are feeling the strain of a lockup in lending, particularly in the market for commercial paper.

To that end, the Fed invoked Depression-era emergency powers to begin buying commercial paper — short-term funding that many companies rely on to pay their workers and buy supplies.

The government’s bailout package is aimed at thawing lending by buying rotten mortgages and other bad debts from banks and other financial institutions. By getting these bad debts off bank’s balance sheets, they might be in a better position to raise capital and more willing to lend to each other and to customers.

Tight credit has made it increasingly difficult and expensive for companies to raise money to fund their operations. Commercial paper is a way of borrowing money for short periods, typically ranging from overnight to less than a week.

In more normal times, about $100 billion of these short-term IOUs were outstanding at any given time, sold by companies to buyers that included money market mutual funds, pension funds and other investors. But this market has virtually dried up as investors have become too jittery to buy paper for longer than overnight or a couple of days.

The unstable situation has left many companies vulnerable. The notion under the plan is for the government to provide a “backstop” that would give companies a new place to get cash, the Fed said. The action makes the Fed a crucial source of credit for nonfinancial businesses in addition to commercial banks and investment firms.

The Fed said it planned to stop buying commercial paper on April 30, 2009, unless the Federal Reserve board agrees to extend the program. The Fed created a separate entity to pool and hold the commercial paper it buys. The Fed said this should allow the central bank to more easily manage the program and better control risk.

There was $1.61 trillion in outstanding commercial paper, seasonally adjusted, on the market as of last Wednesday, according to the most recent data from the Fed. That was down from $1.70 trillion in the previous week. Since the summer of 2007, the market has shrunk from more than $2.2 trillion.

“The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding,” Bernanke explained.

Bernanke believed the Fed’s bold actions — along with the $700 billion financial bailout signed into law by President Bush on Friday — will help restore confidence in financial markets and help them function more normally.

“These are momentous steps, but they are being taken to address a problem of historic dimensions,” he said.

He also defended the timing of the actions by the Fed and the Bush administration. “We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased. This is not the situation we face today,” he said.

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