The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (US)

On September 16, 2008, a day after Lehman Brothers filed for bankruptcy protection, the $62 billion Reserve Primary Fund money market mutual fund (MMMF) “broke the buck,” announcing a net asset value (NAV) of less than $1 per share because of a large exposure to Lehman Brothers commercial paper (CP). This unexpected action prompted run-like redemption requests by many MMMF investors. In the week following Lehman’s bankruptcy, investors withdrew $230 billion from MMMFs, $117 billion of this from prime MMMFs, as they sought out funds investing only in government securities (Adrian, Kimbrough, and Marchioni 2011).

MMMFs scrambled to raise cash to pay redemptions while maintaining their $1 per share NAV, and many funds refused to roll over maturing CP or to purchase new CP, including asset-backed commercial paper (ABCP). Because MMMFs are the largest investor group in CP, their actions had great impact on the CP market. Within a month of Lehman’s bankruptcy, outstanding CP had declined by $300 billion (Adrian, Kimbrough, and Marchioni 2011). Coupled with the retraction in outstanding amounts, CP maturities became severely restricted, and rates soon elevated sharply, all but freezing the market for term CP and ABCP (Adrian, Kimbrough, and Marchioni 2011).

Although needing funds, many funds resisted selling assets at depressed prices. Notably, CP and ABCP combined represented approximately 45% of fund assets, but the secondary market was limited (Duygan-Bump et al. 2012). The secondary market for ABCP began to seize up, making it difficult for issuers to place new paper, and there was concern about possible contagion of the broader financial markets and economy.

To address the redemption stresses on MMMFs, on September 19, 2008, the US Treasury Department announced the Temporary Guarantee Program for Money Market Funds (Temporary Guarantee), which guaranteed MMMF accounts of funds choosing to participate against losses resulting from a fund breaking the buck.^FNSee U.S. Treasury Temporary Guarantee Programs for Money Market Funds. https://www.treasury.gov/press-center/press-releases/Pages/hp1161.aspx and McNamara 2016 for a discussion of the program.  On that same day, the Federal Reserve also announced the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) to provide additional liquidity to borrowers that purchased paper from the MMMFs.

The AMLF provided nonrecourse loans to depository institutions and bank holding companies (Borrowers),^FNEligible AMLF borrowers included US depository institutions, US bank holding companies, US broker-dealer subsidiaries of such holding companies, and US branches and agencies of foreign banks. When used in this discussion, depository institution or bank refers to all eligible institutions, unless the context requires otherwise.  which in turn used the funds to purchase high-quality ABCP from MMMFs that were experiencing redemption pressures. As shown in Figure 1 and further described below, potential Borrowers applied for loans from the Federal Reserve Bank of Boston (FRBB). These loans were secured by specifically identified ABCP to be purchased from an eligible MMMF. The term of the FRBB loan was coexistent with the term of the ABCP, and its principal was equal to the amortized value of the ABCP, which was the prescribed purchase price. The Borrower was required to hold the ABCP until maturity, at which time it repaid the loan and applicable interest at the prime credit rate. Only US-denominated ABCP meeting certain ratings and other criteria was eligible for purchase. 

The FRBB administered the AMLF across all 12 Federal Reserve districts, utilizing existing discount window infrastructure (documentation and processes) and customary transaction parties such as Depository Trust Company (DTC).

Authority for the AMLF

The Fed could not purchase the ABCP outright because of statutory limitations, and so the AMLF was structured to lend the funds to purchase ABCP (Duygan-Bump et al. 2012). Banks, bank holding companies, broker-dealers, and foreign branches were enlisted as potential AMLF intermediaries and borrowers. The Fed relied on Section 10B of the Federal Reserve Act (FRA),^FN12 USC 347b(a), as amended: FRA §10B. Advances to Individual Member Banks. which authorized Reserve banks to make usual lending to depository institutions (FOMC Minutes September 19, 2008). Additionally, the Fed then relied on its emergency authority under Section 13(3) of the FRA—which permitted it to make loans to any individual, partnership, or corporation in “unusual and exigent circumstances” if the Fed determined that the entity was “unable to secure adequate credit accommodations from other banking institutions.” Pursuant to Section 13(3), the Fed could authorize the Federal Reserve banks to make loans directly to broker-dealers and bank holding companies.^FNThe Fed did authorize direct lending to MMMFs under 13(3). On October 3, 2008, the Fed approved the Direct Money Market Mutual Fund Lending Facility (DMLF), which provided for direct lending to MMMFs. After approval, consultation with market participants indicated that they would not use the facility, most likely because of “statutory and fund-specific limitations,” and the DMLF was rescinded by notation vote, dated October 10, 2008, without implementation (Fed. Res. Mins Oct. 3, 2008). The DMLF may be indicative of the Fed’s limited knowledge of MMMFs, a type of entity that it did not regularly deal with, or of the extreme pressure and urgency in the face of which it was compelled to make decisions and design billion-dollar rescue facilities.
“As staff discussed potential options with money fund managers, however, a seemingly insurmountable problem became apparent: Even if the Fed were willing to lend to MMFs, some funds lacked the authority to borrow money, and even those that had the authority generally were extremely reluctant to use it because they feared that disclosure of their borrowing would spook investors.”
https://www.brookings.edu/wp-content/uploads/2018/08/02-Novel-LOLR-Prelim-Disc-Draft-2018.09.11.pdf.     

Eligible Borrowers

To be considered eligible to borrow under the AMLF, a potential Borrower had to have in place with any Federal Reserve bank a master agreement that permitted borrowing from the discount window and (after June 26, 2009) enter into the AMLF Form of Letter Agreement (AMLF Agreement), agreeing to the terms of the program. If it did not, then it needed to complete the Operating Circular No. 10 documents for establishing discount window eligibility, submitting the documents to its local Federal Reserve bank. There were differing registration documents for US entities and for branches of non-US entities. An unregistered entity could also utilize a registered entity as a correspondent through which it arranged the borrowing by completing a Form of Correspondent Credit and Payment Agreement. (See Appendix A.)

Additionally, a potential Borrower that was a broker-dealer participating in the Primary Dealer Credit Facility (PDCF)^FNThe PDCF was a Fed lending program established under FRA Section 13(3) for primary dealers that operated similar to discount window lending as it functioned as a lender-of-last-resort facility. See Wiggins and Metrick 2015 for a discussion of the program. could rely on its authorizing documentation under the PDCF to satisfy the AMLF resolution requirements (AMLF FAQs).

A commentator emphasizes that main Borrowers under AMLF were bank holding companies, and this was crucial in the operations of this program, as the Fed was their sole regulator. This meant that the Fed did not have to coordinate with other bank regulators in allowing regulatory forbearance.

Requesting an Advance under the AMLF

A Borrower requested an advance under the AMLF by completing the ABCP MMMF Liquidity Facility Request Form,^FNDocument is referred to in the research but has not yet been located. which required specific details regarding (i) the collateral to be purchased, (ii) the MMMFs that it was being purchased from and (iii) after June 26, 2009, share confirmation information from the MMMF’s transfer agent to satisfy the redemption threshold (discussed below). (AMLF FAQs).  

After June 26, 2009, any Borrower that had filed the Circular No. 10 documents prior to that date had to also submit, prior to any new extension of credit, the FRBB’s certification governing ABCP eligibility^FNDocument is referred to in the research but not yet located.
 (AMLF FAQs).

The AMLF required that the ABCP that would be purchased and that would secure the loan had to be transferred to the FRBB’s restricted account at the DTC before an advance/loan was approved. Once the ABCP was recorded, determined to be eligible, and valued, the loan funds would be transferred to the Borrower, which would then pay the MMMF.

Summary of Loan Terms

The Borrower was required to purchase the eligible ABCP collateral at the “amortized cost,” which was defined for purposes of the AMLF as “the Fund’s acquisition cost of the ABCP as adjusted for amortization of premium or accretion of discount on the ABCP through the date of its purchase by the Borrower.” (AMLF T&Cs). In all cases, the amount of the loan equaled the purchase price of the ABCP collateral.

The term of an AMLF loan matched the maturity of the ABCP collateral that was purchased with, and secured, the loan. Allowable terms varied from overnight to 270 days. For Borrowers that were banks and bank holding companies, no advance under the AMLF could extend beyond 120 days. For Borrowers that were not banks, terms could extend up to 270 days. Prepayment of the AMLF loans was not permitted, in whole or in part, except in the event of bankruptcy or receivership of the Borrower. 

Loans under the AMLF were extended at the discount window’s primary credit rate in force on the date of the loan, and no other fees applied. During AMLF’s tenure, the primary credit rate ranged from 2.25%, at its inception, to 0.50% at its expiration. Rates were fixed for the term of the loan.

Loans Were Secured and Nonrecourse

Unlike under many Fed liquidity programs implemented to fight the crisis, no haircut was applied to the ABCP purchased. Also, unlike some programs, AMLF loans were nonrecourse to the Borrower if said Borrower complied with the AMLF requirements. If the Borrower failed to repay the Federal Reserve’s loan, the Borrower could surrender the ABCP. Additionally, the risk that the value of the ABCP would decrease was borne by the Fed, not the Borrower. This risk was transferred to the Fed once the ABCP had been approved as AMLF-eligible and the Borrower had successfully transferred the securities to the FRBB’s account at the DTC.

Eligible ABCP Collateral

The ABCP securing an AMLF loan had to be of high quality and meet certain specific criteria. Originally, AMLF-eligible collateral was limited to ABCP that:

• was US-dollar-denominated;
• was purchased by the Borrower on or after September 19, 2008, from a registered investment company that held itself out as an MMMF;

• was purchased by the Borrower at the MMMF’s “amortized cost”—acquisition cost as adjusted for amortization of premium or accretion of discount on the ABCP through the date of its purchase by the Borrower;

• was rated A-1/P-1/F1 by at least two Nationally Recognized Statistical Rating Organizations (NRSROs). If rated by only one NRSRO, the ABCP must have been rated within that NRSRO’s top rating category;
• was issued by an entity organized under the laws of the United States or a political subdivision thereof under a program that was in existence on September 18, 2008, and actively issuing eligible ABCP directly to market investors; and
• had a stated maturity that did not exceed 120 days if the borrower was a depository institution, or 270 days if the borrower was not a depository. (ABCP that had an extendable maturity could not be eligible collateral.) (AMLF T&Cs).

Amortized Cost

To prevent sales at depressed values that might incite another MMMF to “break the buck,” the Fed required the Borrower to purchase the ABCP at the MMMF’s amortized cost (the carrying value of the investment in the MMMF’s accounting records). A commentator notes that this was a necessary feature for any MMMFs to have incentives to participate. A purchase from the MMMF at amortized cost caused no detriment to remaining MMMF shareholders and, therefore, did not create further incentives for MMMF shareholders to redeem shares and place further liquidity pressure on the MMMFs (FR OIG 2010). MMMFs determined the amortized cost, and Borrowers certified to the purchase of the pledged ABCP at amortized cost as a condition of program participation.

Credit Ratings

Given that the AMLF loans were nonrecourse to the Borrowers, the credit ratings for eligible collateral were set high, and the FRBB daily reviewed the credit ratings of collateral for impairment.^FNFR OIG 2010. Some limited impairment did occur. As of May 27, 2009, the Fed reported $1 billion in AMLF collateral was rated A-1/P-1/F1 but on watch for downgrade, and less than $500 million was rated below A-1/P-1/F1, due to deterioration that occurred after it was pledged (FR Bd Gov June 2009). Even so, on April 22, 2009, the criteria for eligible collateral were tightened to require that AMLF-eligible ABCP be rated no lower than A-1/P-1/F1 (by any rating agency) at the time it was pledged. Additionally, paper that was rated A-1/P-1/F1 but was on “negative watch” for downgrade by any major NRSRO was excluded^FNThe initial standard would have permitted a lower rating as long as two NRSROs had rated it at the A-1/P-1/F1 level. Paper with this rating that was on a “negative watch” for downgrade would also have qualified. (FR OIG 2010).

Redemption Threshold

On June 25, 2009, a second program modification was adopted, a redemption threshold that required that MMMFs seeking to sell ABCP pursuant to the facility had to have experienced recent material outflows (AMLF FAQs). The redemption threshold is discussed in detail below.

Eligible MMMFs

As originally enacted, the AMLF was open to any fund that qualified as an MMMF under Securities and Exchange Commission Rule 2a-7,^FN17 CFR 270.2a-7. Among other things, Rule 2a-7 sets out the limits of what MMMFs can invest in. issued pursuant to the Investment Company Act of 1940 (Rule 2a-7). Although one of the stated purposes of the program was to “help restore liquidity to the ABCP markets and thereby to help money funds meet demands for redemption,” at first a selling MMMF did not have to meet any specific standard or provide proof that it had suffered significant or unusual redemption requests (AMLF FAQs). This is largely explained by the Fed’s Inspector General in a 2010 report by reference to the emergency that they faced and time constraints. The focus was on addressing the runs on MMMFs and unlocking the ABCP market:

“Operationally, the AMLF’s original policies and procedures were established quickly to address the financial crisis in the ABCP market that led to MMMF redemptions. . . . Based on the severe market stress conditions that existed at the time and the pressure of investor redemption demands on the MMMFs, the AMLF terms did not specifically require that the ABCP be purchased solely from MMMFs experiencing material ‘redemption pressure’” (FR OIG 2010).  

It should also be noted that the AMLF was the first facility put in place by the Fed following Lehman’s bankruptcy and the first in which the Fed sought to address distress among entities that it did not regularly deal with and a specific market.

As stated above, AMLF-eligible collateral had to be purchased from an eligible MMMF after September 19, 2008.

Redemption Threshold Defined

After the initial aggressive utilization of the facility had subsided, the FRBB’s review revealed that some funds utilizing the facility might not have experienced significant redemption requests. To refocus the program, on June 25, 2009, a redemption threshold was established.

Under the new requirement, which was intended to ensure that the facility was utilized as a backstop to fund redemption requests, Borrowers could only pledge to the AMLF ABCP that was purchased from an MMMF that had experienced material outflows, which were defined as:

• outflows of at least 5% of the MMMF’s net assets in a single day; or
• outflows of at least 10% of the MMMF’s net assets within the prior five business days or less (FR PR June 25, 2009).

Material outflows were calculated as “net redemptions”—“redemptions less shares sold and dividends reinvested . . . calculated based on changes in the end of day net asset levels viewed at the consolidated fund level” (AMLF FAQs). Fluctuations in individual share classes of a fund were not considered in determining whether the fund was eligible to pledge ABCP to the AMLF (AMLF FAQs).

Because the FRBB could not verify net asset redemption levels using publicly available information, an MMMF seeking to sell ABCP pursuant to the AMLF was required to secure from its transfer agent a Certification Letter certifying to changes in the fund’s share levels (as an approximation of end-of-day net asset levels), over the prior 10-day period. The MMMF would need to provide this letter to the Borrower, which would submit it to the FRBB with the Request for Advance. (See Figure 2 for an example of how the redemption threshold and eligibility period operated.)

Eligibility Period

Once an MMMF experienced the trigger level of material outflows, any eligible ABCP satisfying the applicable eligibility requirements purchased from the MMMF on the five business days following the trigger day could be pledged pursuant to the AMLF. The five-day eligibility period was intended to provide funds a way to manage the redemption event. They would be able to utilize the AMLF the next day if redemptions continued but did not quite reach the eligibility trigger levels. If redemptions subsided after a day or two, the MMMF could choose not to utilize the AMLF. Additionally, if the trigger level was again met at any time (even during the original five-day eligibility period), a new five-day period would begin.  Once an eligibility period ended, the MMMF would be ineligible for the program until it again experienced an eligibility-triggering event.

Administration by FRBB

The FRBB administered the AMLF and was authorized to make loans to eligible Borrowers on behalf of the other Reserve banks. All AMLF loans were recorded as assets by the FRBB. For loans extended to Borrowers that settled to depository accounts in districts other than Boston, the funds were credited to the Borrower’s depository account by the appropriate Reserve Bank and settled between the Reserve Banks through the interdistrict settlement account.

The FRBB reported the weekly average and Wednesday amounts of AMLF credit outstanding on its H.4.1 weekly statistical release. Beginning on June 10, 2009, the Fed also included additional anonymous information on AMLF transactions in its monthly reports (Federal Reserve Credit and Liquidity Programs and the Balance Sheet). This information included the number of Borrowers, Borrower by type of institution, collateral by type and credit rating, and data on the concentration of borrowing. No public disclosure was made of the individual Borrowers participating in the program or the amount of loans made to such Borrowers until 2010, when the Fed was compelled to make such disclosure under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Borrower Administrative Issues

Because some Borrowers would be regulated banks and bank holding companies, the question arose as to how the ABCP purchased with AMLF loans would impact such entities’ reporting and capital requirements. To facilitate AMLF operations, the Fed adopted temporary limited exceptions to (i) its leverage and risk-based capital rules, and (ii) its restrictions on affiliate transactions (FR OIG 2010).

Because the Borrower would bear no credit or market risk in holding ABCP pursuant to the AMLF, the Borrower would not be assessed any regulatory capital charge with respect to such ABCP, and such ABCP would receive a 0% risk weight for risk-based capital purposes and would be excluded from average total consolidated assets for leverage purposes. Also, under the AMLF, Borrowers could purchase ABCP from affiliates, and so such transactions were exempted from the usual restrictions on affiliate transactions.

The first loans made pursuant to the AMLF occurred on September 22, 2008, and maximum outstanding loans peaked at $152.1 billion on October 1, 2008, which equaled 21% of then-outstanding ABCP. Borrowings declined thereafter as the market stabilized and redemption pressures waned. As of December 17, 2008, the aggregate amount of outstanding advances under the AMLF was $27.4 billion. (See Figure 3.)

There was a bounce of activity from April 24 to May 8, 2009, prior to the government’s pending release of its Supervisory Capital Assessment Program (SCAP)^FNSee Ross 2016 for a detailed description of the SCAP. (also known as the bank stress tests) results. There was the possibility that the tests might result in some ABCP issuers being downgraded, which would have reduced the credit rating of their ABCP and, thus, made such ABCP ineligible for AMLF funding (FR OIG 2010). When the Fed’s later review revealed usage by funds that had not likely experienced unusual redemption requests, it was prompted to adopt the redemption threshold as discussed above.

Borrowers, Paper Purchased & MMMFs That Sold

During the program’s tenure, AMLF Borrowers purchased ABCP from 105 MMMFs, or 42% of AMLF-eligible prime MMMFs. The ABCP purchased was issued by 90 out of 170 active ABCP issuers and 47 out of 71 unique ABCP sponsors. The average AMLF loan was $68 million and had an average maturity of 47 days and a maximum of 168 days (Duygan-Bump et al. 2012).

There were seven Borrowers under the AMLF when viewed on a consolidated group basis,^FNIn some cases, more than one related entity of a holding company was the named Borrower. For example, JPMorgan Chase Bank and JPMorgan Chase Broker Dealer were both Borrowers (AMLF Trans. Data). but borrowings were dominated by just two, State Street Corporation and JPMorgan Chase & Co., which borrowed total amounts of $89 billion and $111 billion, respectively, or an aggregate of 92% of the amounts lent pursuant to the program (Condon 2011). Other institutions participating in the AMLF included Bank of New York Mellon (BNY Mellon), Citigroup, Bank of America, SunTrust Banks Inc., and Credit Suisse Group AG (AMLF Trans. Data). No institution that asked to borrow was rejected (Condon 2011).

JPMorgan Chase and BNY Mellon used AMLF funds to purchase ABCP from funds run by their own money-management units as well as from other funds. JPMorgan Chase used $17.6 billion, or 16% of the total that it borrowed, for this purpose. In BNY Mellon’s case, it used $11.5 billion, or 89% of the $12.9 billion that it borrowed, to purchase ABCP from its proprietary funds (Condon 2011).

A commentator emphasizes that the main borrowers under AMLF were bank holding companies, and this was crucial in the operations of this program, as the Fed was the sole regulator of them. This meant that the Fed did not have to coordinate with other bank regulators in allowing for regulatory forbearance and other operations.

Vanguard Group Inc. and Legg Mason Inc. were the only money fund providers among the top 10 that did not utilize the AMLF. Not surprisingly, the Reserve Primary Fund was the fund that sold the most ABCP pursuant to the AMLF, selling a total of $19.4 billion while the fund was liquidating (Condon 2010).

Wind-down and Expiration

Because of improved market conditions for ABCP (and possibly also the existence of other Fed programs, such as the Commercial Paper Funding Facility (CPFF),^FNSee Wiggins 2017 for a description of the CPFF. which also purchased AMLF-eligible ABCP), the last borrowing under the AMLF occurred on May 8, 2009, and matured on August 3, 2009. All loans made under the facility were repaid in full, with interest totaling $543 million, in accordance with the terms of the facility. The AMLF was originally established with an expiration date of January 30, 2009; however, the Fed extended the program three times, and it finally expired on February 1, 2010.