The template is its September 19th announcement that it would finance banks' purchases of asset-backed commercial paper from money-market funds.
The hope is that investors will buy into this fund, and it will unfreeze the short-term asset-backed commercial paper market.
The Federal Reserve responded with several programs, including a facility to finance bank purchases of high-quality asset-backed commercial paper from money market mutual funds.
No. 12, "speculative areas beyond housing may suffer in 2007, " has commenced with the evaporation of the asset-backed commercial paper market last summer and the drying up of private equity financing.
Turns out that the Primary Fund, like many other money market funds, made significant investments in asset-backed commercial paper (ABCP), which offered juicy yields, but did so because they were backed by things like mortgages, auto loans, credit card receivables and other risky assets that, despite their risk, came with investment-grade ratings.
For this reason, ad hoc responses will still be critical, such as last week's federal guarantees for money-market funds, Fed loans to banks to buy asset-backed commercial paper and, on Sunday, approval of the remaining two big independent investment banks, Morgan Stanley and Goldman Sachs, to become Fed-regulated bank holding-companies whose investment bank units can now borrow from the Fed on the same terms as other banks.
For some banks, the combined issuance of asset-backed securities and commercial paper (short-dated securities) amounted to about half of all their loans.
Recreating its backstops for money-market funds, commercial paper and asset-backed securities might require such stringent conditions that no one would participate.
But it is too soon to tell whether the vehicle will ever be restored to its former pre-credit-crunch glory, when it was able to issue short-term commercial paper to fund its investments in asset-backed securities.
Known as conduits, these special-purpose vehicles borrow in the short-term, commercial-paper market to make acquisitions of highly rated paper in American asset-backed securities, and have been walloped by the plunging value of those assets since the frailty of subprime loans were exposed.
Moreover, providing liquidity to financial institutions does not address directly instability or declining credit availability in critical nonbank markets, such as the commercial paper market or the market for asset-backed securities, both of which normally play major roles in the extension of credit in the United States.
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