NEW YORK (CNNMoney.com) -- The Federal Reserve announced a new program to help the battered market for short-term business loans - taking its closest step yet to lending directly to businesses.
The program addresses commercial paper, a form of short-term funding that is crucial to many businesses operations.
Commercial paper is sold by major corporations and most of the nation's leading financial institutions. They use the proceeds to fund day-to-day business operations. It is bought primarily by money market fund managers and other institutional investors.
Before the current credit crisis, there was nearly $2 trillion of commercial paper outstanding and was mostly issued for short terms - never more than nine months - and thus had to be renewed frequently.
For investors, it was considered a very safe investment to purchase and one that could be easily resold to other investors.
In the past month, the amount of money outstanding in commercial paper loans has fallen 11% to a seasonally adjusted $1.6 trillion on Oct. 1 from $1.82 trillion on Sept. 10.
The decline in available funding indicates only part of the market's problems, however. Investors have also become unwilling to buy longer-term paper - beyond a week or two - from even companies and financial institutions with top-flight credit ratings.
Federal Reserve officials speaking on background to reporters said that the overwhelming majority of the paper outstanding is coming up for renewal in the next several days and companies needing to use the money could face trouble when they try to renew it.
Experts in the field say the market really fell apart after Lehman Brothers, the nation's No. 4 Wall Street firm at the time, filed for bankruptcy on Sept. 15. The firm's collapse essentially wiped out the value of its commercial paper and scared money market managers out of the commercial paper market and into Treasurys.
Federal Reserve officials say they hope that the Fed's entry into the market will give money markets and other investors confidence to reenter the market because they know they will be able to sell that paper to the Fed as a backstop. So they hope the central bank will not have to actually buy much of the commercial paper in order to restore confidence in the market.
Fed officials said there is no limit to the amount of commercial paper it could buy. They said that market conditions - and the decisions of investors - will determine the extent to which the government will have to step in.
Many of the details of the program, including when it will be open for business, had not yet been settled as of Tuesday's announcement.
The Fed will buy only top-rated commercial paper, of which there was about $1.3 trillion outstanding in August. About $100 billion of that was in the form of unsecured loans to non-financial firms, and about $600 billion was to financial firms. The other approximately $600 billion is backed by assets at the firms issuing the paper, although that is generally considered unsecured lending as well.
Much of the commercial paper outstanding at the start of the credit crisis is now coming up for renewal, As a result, fears have grown that the market could drop even more sharply without some drastic improvement in the market.
Under the program announced Tuesday morning, the Fed will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The program is slated to expire in April 2009 and will have financial support from taxpayers.
"The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility," said the Fed's statement.
The new program comes as the Treasury Department scrambles to put in place a $700 billion bailout of the financial system enacted on Friday. Under that program, the Treasury is expected to purchase troubled assets from banks and financial institutions in an effort to spur more lending.
