The encyclopedia · Finance & Accounting · Operational decision · 2008–2009
The Fed saved money-market funds by lending through banks it could not lend to directly
When money market funds faced a run, the Fed lent banks money to buy the funds' paper, non-recourse, so the funds got cash.
Federal Reserve System · Federal Reserve Bank of Boston · U.S. money market mutual funds
the move
In September 2008 the Reserve Primary Fund broke the dollar, and money market mutual funds faced redemption runs. Funds were major holders of asset-backed commercial paper, but the Fed cannot lend to a fund directly, so the standard rescue route was closed.
The AMLF, adopted 19 September 2008 and opened 22 September, solved this by lending to banks and bank holding companies on a non-recourse basis, on condition the proceeds buy ABCP from the funds at amortized cost. That let the funds sell their paper for cash without taking a loss that would make the run worse.
The design worked because the borrowing bank bore no credit or market risk, and the Fed granted a capital exclusion so the paper did not count against the bank's leverage and risk rules. The bank was just a legal channel; the Fed took the economic risk to stop a system-wide run.
why it works
- The Fed could not lend to a fund, so it lent to banks and let them buy the paper instead
- Non-recourse lending meant the bank took no credit risk, making the pass-through cheap to accept
- Buying at amortized cost avoided forcing funds to sell at a discount that could lock in losses
- Capital relief removed a regulatory penalty that would have discouraged participation
what transfers
When your legal counterparty is wrong, you can still fix the market by lending to someone who can reach it, provided the borrower carries none of the risk.
what came after
Outstanding AMLF advances reached about $96 billion by late October 2008, and the facility was extended and then wound down in 2009 as money-market stress eased. It was one of several emergency facilities credited with calming the panic.
references
- Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (final rule, E9-2336)
- Reports Pursuant to Section 129: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility
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