Commercial paper - a low-risk, cost-effective debt instrument used for short-term loans and issued by firms with high-quality debt ratings - is used by many companies to finance day-to-day operations. Recently, however, the market for commercial paper has been virtually frozen.

Under the plan, the government would ease stress in the market by supplying a back door that would provide companies with a new facility to access loans. The Fed would act like a commercial bank or an investment firm that could be a source of credit for non-financial businesses.

"The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers," the Fed said in a press release.

"The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants."

The Fed said that increased investor demand in the market should lower commercial paper rates from current elevated levels and foster the issuance of longer-term commercial paper.

According to the Treasury, the facility is "necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility."

The Fed added that, "By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market."

The extraordinary move by the Fed didn't come as a total surprise to markets, as the Fed had hinted at the move on Monday when it said it was exploring "ways to provide additional support" to "unsecured funding markets," including creating a separate legal entity expressly for this purpose.

In a conference call an hour after the announcement, Fed officials said the CPFF will not begin in the next few days, but as soon as possible.

The total market for commercial paper is $1.3 trillion dollars, and though the facility's holding remains undetermined, officials said it will be "nowhere near" that amount, though it will be "substantial."

By Erik Kevin Franco, This email address is being protected from spam bots, you need Javascript enabled to view it and Patrick McGee, This email address is being protected from spam bots, you need Javascript enabled to view it

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