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Fed Aims to Unfreeze Credit Markets With Plan to Buy Short-Term Debt

“Continued efforts to stabilize the financial markets are essential,” Fed chairman Ben Bernanke said in remarks to the National Association for Business Economics, speaking of the new plan and other recent Fed actions. “The Federal Reserve will continue to use the tools at its disposal to improve market functioning and liquidity.”

The Fed will invoke emergency powers to establish a special fund to buy “commercial paper.” Commercial paper is the short-term debt companies sell to fund day-to-day operations like purchasing supplies and making payroll. The Fed and the Treasury Department will jointly fund the new entity, called the “Commercial Paper Funding Facility.”

“This facility should encourage investors to once again engage in term lending in the commercial paper market,” the Fed said in a statement, according to the New York Times. “An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.”

There are generally about $100 billion worth of these debts outstanding at any time, according to the Associated Press, bought by investors such as mutual funds and pension funds. As investors have become increasingly nervous over the past several weeks, however, the usual market for commercial paper has dried up — and companies are beginning to have a hard time raising the cash they need to continue their operations.

The Fed drew up its plan as the U.S. stock market slid to its lowest point in years on Monday. The Dow Jones industrial average fell 3.6 percent, closing below 10,000 for the first time since 2004. It had been down nearly twice that earlier in the day, before recovering somewhat in afternoon trading.

The market’s fall showed that investors and creditors were still fearful, despite the $700 billion financial rescue package approved by Congress last Friday.

The crisis was also spreading around the world Monday, as markets tumbled in Europe and Asia. Stock indexes fell 7 percent in Germany, 8 percent in Britain, 9 percent in France, and nearly 20 percent in Russia. In Asia, Japan’s Nikkei index was down 3 percent and Korea’s Hang Seng index fell 4.9 percent.

“There is a growing recognition that not only has the credit crunch refused to be contained, it continues to spread,” investment strategist Ed Yardeni told the New York Times. “It’s gone truly global.”

The U.S. stock market was up slightly Tuesday morning, buoyed by news of the new commercial paper funding facility, but fell again in afternoon trading.

In his speech Tuesday to the National Association for Business Economics, Bernanke said the outlook for economic activity for the rest of this year and into next year was “subdued,” and he signalled that the Fed might be willing to consider cutting interest rates in the near future.

“The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth,” he said.

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