The Federal Reserve backstop to money funds is one part of a three-part program run by the Fed to lend help to money funds that was created after The Reserve broke the buck with a money fund in September.
That facility will provide liquidity directly to money funds and is designed to provide fund managers the confidence to extend significantly the maturities of their investments as well as reduce the funds' reliance on sales to the Federal Reserve's special-purpose vehicle. The program will last as long as conditions in financial markets are are unusual and exigent.
The hearing is ongoing.
Excerpt from Bernanke's testimony:
Normally, money market mutual funds are major lenders in the commercial paper markets. However, in mid-September, a large fund suffered losses and heavy redemptions, causing it to suspend further redemptions and then close. In the next few weeks, investors withdrew almost $500 billion from prime money market funds. The funds, concerned about their ability to meet further redemptions, began to reduce their purchases of commercial paper and limit the maturity of such paper to only overnight or other very short maturities. As a result, interest rate spreads paid by issuers on longer-maturity commercial paper widened significantly, and issuers were exposed to the costs and risks of having to roll over increasingly large amounts of paper each day.
The Federal Reserve has developed three programs to address these problems. The first allows money market mutual funds to sell asset-backed commercial paper to banking organizations, which are then permitted to borrow against the paper on a non-recourse basis from the Federal Reserve Bank of Boston. Usage of that facility peaked at around $150 billion. The facility contributed importantly to the ability of money funds to meet redemption pressures when they were most intense and remains available as a backstop should such pressures reemerge.
The second program involves the funding of a special-purpose vehicle that purchases highly rated commercial paper issued by financial and nonfinancial businesses at a term of three months. This facility has purchased about $250 billion of commercial paper, allowing many firms to extend significant amounts of funding into next year.
A third facility, expected to be operational next week, will provide a liquidity backstop directly to money market mutual funds. This facility is intended to give funds confidence to extend significantly the maturities of their investments and reduce over time the reliance of issuers on sales to the Federal Reserve's special-purpose vehicle. All of these programs, which were created under section 13(3) of the Federal Reserve Act, must be terminated when conditions in financial markets are determined by the Federal Reserve to no longer be unusual and exigent.
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