WASHINGTON (CN) – In the face of massive investor withdrawals from money market mutual funds that were losing value after the failure of investment firm Lehman Brothers, the Federal Reserve began loaning money to banks to buy asset backed commercial paper from mutual funds. The program, which creates liquidity in the market, has been extended until April 30.
The program was to keep mutual funds from breaking the buck (when the value of a share of the fund falls to less than $1) and to facilitate business lending, which relies on commercial paper for day to day operations. The loan program was set to expire Jan. 31, but turmoil in the credit market persists and investors continue to flee to less liquid investments.
If a money market mutual fund experiences a high rate of redemptions it can sell asset backed commercial paper to a bank that buys the paper with a loan from the Fed. The difference between the rate of the loan and the rate for which the paper was purchased is profit to the bank, and the risk of the paper is transferred to the Federal Reserve.
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