Established in the wake of Lehman Brothers’ bankruptcy to stabilize severe disruptions in the commercial paper market, the Commercial Paper Funding Facility (CPFF) allowed the Federal Reserve to act as a lender of last resort for issuers of commercial paper, thereby effectively addressing temporary liquidity distortions and alleviating the severe funding stress that threatened to further exacerbate the financial crisis. In doing so, the CPFF can be considered a noteworthy model of liquidity provision in a market-based financial system, where maturity transformation occurs outside of the commercial banking sector. Authored by Tobias Adrian, Karin Kimbrough and Dina Marchioni, this paper examines the creation and performance of the CPFF, while simultaneously outlining the evolution and importance of the commercial paper market before and during the CPFF (which expired February 1, 2010).
Supported by in-depth analysis, detailed data and first-hand accounts, this paper offers a complete overview of the CPFF, including the economic role of the commercial paper market, the events preceding the creation of the facility, operational details of the CPFF and the economics of the facility in the context of the financial system and in relation to the Federal Reserve’s role as lender of last resort.
As explained by the authors, the careful operational design of the CPFF permitted the Federal Reserve to effectively relieve temporary stress in the commercial paper market while protecting itself from any credit loss. Moreover, the facility’s ability to provide liquidity to a particular market as opposed to a particular set of institutions allowed the Federal Reserve to extend its reach beyond depository institutions, a critical factor given the primacy of institutions without discount window access in the commercial paper market.
Fashioned as a market-based liquidity facility that naturally wound down as the private sector regained its footing, the CPFF serves as a guide for providing emergency backstop liquidity to modern financial markets, where “the shadow banking system” accounts for a quantitatively and economically important share of the activity. Additionally, while the public sector’s role in providing backstop liquidity to the shadow banking system will continue to be debated, the CPFF’s successful design could serve as a guide for future policy discussions about reducing the vulnerability of markets to liquidity crises.
Tobias Adrian is an assistant vice president, and Karin Kimbrough and Dina Marchioni are Markets officers at the Federal Reserve Bank of New York.