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Commercial Paper
COMMERCIAL PAPER....Banks, finance companies, and large corporations routinely finance their ongoing operations by issuing short-term debt known as commercial paper. It's denominated in large amounts (typically a million dollars or more), it's unsecured, it's low cost, it matures quickly (typically in 30 days or so), and it can be issued easily because it doesn't have to be registered with the SEC. Without access to commercial paper, large modern corporations would seize up and die.
Which, unfortunately, is what's happening right now. The commercial paper market is essentially frozen, and as notes mature and need to be rolled over, companies are finding it impossible to get routine financing. (This is how "Wall Street problems" turn into "Main Street problems.") So today, the Fed announced plans to step in:
As pressure built in the credit markets and stocks spiraled lower around the world on Monday, the Federal Reserve was considering a radical new plan to jump-start the engine of the financial system.
....The Fed plan is intended to renew the flow of credit on which the economy depends. Under its plan, the central bank would buy unsecured commercial paper, essentially short-term i.o.u.'s issued by banks, businesses and municipalities.
And there's more:
On Monday, the Fed announced that it would once again redouble one of its key emergency lending programs, increasing the size of its Term Auction Facility to $600 billion, from $300 billion. On top of that, the central bank plans to provide an additional $300 billion to banks to meet their end-of-the-year cash needs.
To pay for its burgeoning responsibilities, the Fed has no choice but to keep printing more money. To prevent that flood of new money from reducing the central bank's overnight interest rate to zero, the Fed also announced on Monday that it would start paying interest on the excess reserves that banks keep on deposit at the Fed.
Paying interest on reserves allows the central bank to set a floor on interest rates and retain at least some control over monetary policy. In its announcement on Monday, the Fed said it would pay an interest rate of 1.25 percent — three-quarters of a point below its target of 2 percent for the overnight Federal funds rate.
That's a lot of activity for one day, no? Normally, I'd say that stepping into the commercial paper market is a pretty stunning move for the Fed, which is decidedly not in the business of financing corporate operations. But after the events of the past year it seems almost anticlimactic. Before long you'll be getting your auto loans directly from the Fed.
Just to put this in perspective, though, it might actually be a bigger deal than the bailout bill we just spent the past two weeks going berserk over. But it will happen with hardly a peep regardless. I don't think anybody's in the mood to peep right now.
And one other note: remember that $7 billion that California governor Arnold Schwarzenegger wanted to borrow from the Fed because the credit markets were frozen? That was for the purchase of Revenue Anticipation Notes, which are routinely used to finance ongoing operations while the state is waiting for tax revenue to arrive in the spring. Unless I'm wrong (and I might be), this is basically a form of commercial paper, which means that California might get its wish. Instead of issuing the RANs privately and paying high rates (if there are any buyers at all), California may be able to make use of the new Fed facility instead. Frankly, I'm not sure we deserve it, but who said life was fair?
Hmmm.
These financial institutions that were more interested in executive pay are now issuing non-secured commercial paper that the FED is buying.
All during a huge downturn where most are going under.
Sounds like the FED is giving money away
Keep that printing press whirring away.
Henry Paulson is the ML Carr of the economy
Just to put this in perspective, though, it might actually be a bigger deal than the bailout bill we just spent the past two weeks going berserk over.
And to think, we coulda just bought the damn banks. Just to keep the system running.
max
['But hey, Goldman-Sachs uber alles!']
"The commercial paper market is essentially frozen"
Just curious, where is the data for this? I'm not disputing your point, I've heard it from some, but others say that it's not true. (Including, I think, if I understand him and I most likely do not, PK.)
Where is the day to day data on this?
Jerry, Listen to the interview on NPR with Joe Nocera, business reporter from the NY Times. Here's the link:
http://www.npr.org/templates/player/mediaPlayer.html?action=1&t=1&islist...
If California can't float short-term bonds--which has to be what RANs really are--then one would have to think we have a capitalization problem, not a fear problem. For all of California problems I assume it is not holding a bunch of CDOs or other mortgage backed securities that make it a risk of default. If Cali is not credit worthy, who is?
Doesn't this turn the Fed into the banking system? At this point, why do we need banks any more? Nationalize them? Just shut them down in an orderly fashion.
I spent the last two weeks going beserk over the Paulson bailout plan because it's a horrid plan. There'd be almost no peep out of me over the proposal by the Fed to buy the commercial paper of financial companies, provided that (1) the Fed's buyers are only going to buy paper that they've got good reason to believe is good paper, and provided also that (2) they're only buying short-term paper. With those conditions met, it'd be radically different from the Paulson plan.
A commenter above was asking for a pointer to data supporting the remark that "the commercial paper market is essentially frozen". Before looking at data at a website such as Bloomberg.com, one should first digest the following kind of background info, also taken from Bloomberg.com:
The same credit crunch gripping banks, brokers and insurers is providing industrial companies with the lowest short-term borrowing costs in almost four years. Yields on commercial paper due in 30 days sold by manufacturers and retailers fell to an average 2.14 percent last week, while those for financial borrowers rose to 3.15 percent.... Money-market funds are pouring cash into Treasury bills and non-financial corporations' paper to avoid the troubled financial corporations.... The greatest demand is for commercial paper with the shortest maturities.
That quote is dated Sept 29, but is still valid today.
The financial companies that have clear, or foggy, exposures to the mortgages securities market meltdown are having difficulty getting their creditworthiness accepted in the commercial paper market. They are being frozen out of the market. But for all other types of companies the commercial paper market is wonderful, bountiful, lush and the opposite of frozen.
"Without access to commercial paper, large modern corporations would seize up and die."
Kevin, you imply that the key problem here is access to commercial paper. But this is just a symptom. Commercial paper would be no problem if the companies actually were profitable/productive/had value. Most recently, the appearance of solvency and productivity and wealth generation by corporations has been maintained by consumers willing to "buy" on credit and corporations and banks willing to believe that somehow those people would be able to pay eventually. But the kinds of jobs and wages they need to pay for these things are long gone and it does not appear that they will be replaced.
So, is anyone keeping track of the total pile of money that we're throwing at these issues? I'm sure that it's well over a trillion by now; maybe approaching two. It would probably be a good idea to tote up this insanity at some point...
It's a huge exaggeration to say that commercial paper is "frozen" and that it's "impossible" to issue routine CP. The Fed's own numbers show that CP volume is down to about what it was in 2006 and interest are up to about what they were in 2006. Given the state of the economy, we'd like rates to be lower as a stimulus, but there's absolutely nothing apocolyptic about 2006 rates or volume in CP.
Jerry -- watch the "TED spread", which is the difference between the three month cost of money to banks and the US Treasury. It's reported daily at sites like Bloomberg. (When they absolutely need the dough, banks have to compete for loans, while the Treasury owns a printing press: that's why the TED spread is a basic indicator.)
In a healthy credit market, Ted spreads 10-50 points. When things are bad, it goes over 100. When things are REALLY bad, it goes over 200.
Last Friday, it was 387 points, the highest since Bloomberg started keeping track during Reagan's first term.
So far this week, it's moved back a bit, to 369 last I looked.
But that's why governments from California to Iceland haven't been able to borrow enough short-term to meet their payrolls. People who ordinarily make three-month loans can't get the money, because people WITH the money are burying it in the backyard. There are major players who are buying T-bills with NEGATIVE value -- literally planning to lose a controlled amount of money over the next few months, because they figure the alternative is worse.
We're at a moment like that scene in Jurassic Park II, when Sarah is sprawled flat on a windshield a few hundred feet over the waves crashing on the rocks, while cracks in the glass are spreading from her fingers and face.
I'm also concerned about the lack of numbers. How many sup prime mortgages are there anyhow? What are the face values of those loans? How many CDOs? Face value of those? Credit swaps, etc. All this stuff is tracked by computers. The number of large financial institutions is relatively small.
Are those numbers out there, but I just don't know where to look? Isn't this the sort of stuff reporters are supposed to find out, and put before the public?
I actually like this move by the Fed. Unlike the bailout money, the short-term commercial loans will be paid back, with interest. I'm not saying I want it to be a long-term solution, but given the circumstances, it makes a lot of sense.
There are basically two kinds of comments in this thread. First, there is "the sky is falling, the sky is falling, do something now" group, and then there is the "I don't trust you--prove the sky is falling crowd." It is too bad the first group doesn't have much credibility with the second.
What can be done to change that? Are we going to have to go through a real depression? That is what my son told me the other day. He thinks a real depression would be bracing for America.
He thinks a "depression" is necessary to change the direction of the American economy. I think he is wrong.
A complete and total bust is the only way to hurt the fascists.Is the cure worse than the disease? Only your grandchildren will know for sure.
Bailing out California is only fair given that Golden Staters have for years paid more in federal taxes than they recoup (seems a lot goes to Alaska), and in light of the Enron ripoff nurtured by the Bushies.
Ron,
I think that there's a lot of people running around the comments sections of various blogs that don't really appreciate exactly what a depression would mean for them. They seem to have this idea that it will happen to everyone *but* them. I'm sorry to burst their bubble, but unless you've got a few million or more stashed away in pure cash, you won't make it out of a full-blown depression unscathed. There will be varying degrees of pain, no doubt, but there will definitely be plenty of pain to go around. Christ, I was just a kid during the 81-82 recession, and we experienced my dad losing his job, having to move into a cheaper house, my dad losing another job, the exhaustion of my parents' life savings, having to move to a different state, being homeless for a while (lived with an uncle, so at least we had a roof over our heads), and finally getting things back to where we had an actual home of our own by 1984. And all of that was due to a simple, yet pretty severe, recession. Anyone that thinks that a depression or severe recession would be "good for us" is talking out of their asses. Recessions and depressions seriously undermine a person's faith in the current economic system, and can lead to all sorts of nastiness and political extremism.
I am starting to wonder whether this is a cynical, last ditch effort by Republicans in the Bush (Paulson) administration to crowd out any ability of any Democratic Party administration to promote social spending--the way David Stockman concluded was happening with the Reaganites enjoying the build up of the federal deficit after giving away the store to rich folks via income tax cuts...
I'm torn. I've bootstrapped my small company for the last two decades because I couldn't put up enough collateral to get a sufficient line of credit from a bank. We built up credit the hard way through vendors.
While some of my richer competitors are suffering from frozen credit, some of my vendors are also on the brink.
Now, the Fed is going to bail them all out while I have to continue bootstrapping.
I've watched the ups and downs of our economy since the late 70s and know with certainty that Republican administrations are not a) fiscally conservative, b) good for Wall Street and especially not c) good for small business.
I think the situation Kevin describes explains the clarification in the Mark-to-market accounting rule. The issue it was trying to address was not the CDOs, but rather the effects holding commercial paper -- regular old commercial paper -- for which there is no market on bank balances. The rule change allows for present value calculations to be used in the absence of an existing market. Clearly, that doesn't seem to have done the trick.
My mind is somewhat boggled by how fast this situation is progressing. I suspect modern technology has fueled panic, and shortened the amount of time reasonable measures have to take effect before people panic more. If the bankers and other private equity holders would just take a deep breath, it might help.
OhNoNotAgain
I agree. My son was too young to have experienced the full blow of the recession in the early 80's. I remember, I remember.
My mother used to tell me about the depression in western Kansas. Her parents were farmers. They lost everything. She went years without new clothes and went hungry many, many times. My father's dad was a wholesale gasoline distributor in western Kansas. My mom told the story that one year my paternal grandfather extended credit to her father to put gasoline in the tractor and that saved their lives. The family legend is that my grandfather did that with a lot of farmers. He knew better, but he did it anyway. In the end my grandfather lost his business. He tried to help too many struggling farmers. Damn near everybody went bankrupt. My mother's family lost most of their land to taxes. Mostly she remembered being hungry.
No, a depression is a horror we don't need.
The California Legislature's Republican rump has adamantly held that we can't raise taxes to pay for government, and thanks to Richard Viguerie, they have an effective veto. So our wily Governator convinced the state's voters to charge it: to float bond issues to pay for government today with future revenues from an unspecified source -- in essence, a promise to raise taxes _double_ in the future.
Ron,
"No, a depression is a horror we don't need."
Exactly. With the way our divided political system looks today, it could get ugly really fast.
Just Being Frank,
"Now, the Fed is going to bail them all out while I have to continue bootstrapping."
I hear ya. I'm in the same boat - completely on a cash basis because we're a software company and don't actually own any assets that could be used as collateral. Still, a decade in business with a proven revenue stream, sound finances, thousands of dollars in the bank just sitting there in cash every month, everything. I couldn't get a line of credit or expansion credit unless I put my house up as collateral (not gonna happen). It was especially infuriating watching all of the money being thrown at the fly-by-night web companies during the Internet boom while we made a consistent profit year after year in a non-flashy segment of the market. It seems like nobody wants a nice, safe, consistent, yet modest, return on their money anymore.
RB writes: "There are basically two kinds of comments in this thread.... the first group doesn't have much credibility with the second."
The effective analogy isn't to the sky falling, which is after all a mistake that leads to a fatal con. Remember the story? Chicken Little is eating when an acorn falls on her head. She decides the sky is falling, and runs to warn the king. She picks up friends (like Henny Penny) on the way, and they finally run into Foxy Loxy, who pretends to believe the sky really is falling, but proceeds to devour most of 'em.
The moral of the story is to be skeptical, which is good advice -- but it's still the wrong analogy.
A better lesson might be to MacKay's possibly apocryphal investor who sold some 17th century knucklehead a tulip bulb for 12 acres of land: which part of that deal retained its value?
Today's action by the Fed is the first that is getting directly at a major financial crisis in this country. We can survive a few bad mortgages. We cannot survive the inability of major companies to fund their operations and their payroll. That is the consequence of the CP market freezing up. Some of the nitwits upthread think companies have little stacks of money sitting in a vault or safe somewhere, to pay thier bills. That ain't the case - there is a daily ebb and flow of money in any large company on a daily basis. Some days they have more money than what they need, some days less. The CP market is the mechanism by which these companies draw from this pool of liquidity or pour into the pool. If the pool is dry, a lot of companies die of thirst. That is why GE had to borrow $5 billion from Warrnen Buffett at usurious rates. GE relies heavily on CP to fund their operations.
If the Fed had not done this, try to imagine GE, Target and IBM not being able to make their payroll and their hundreds of thousands of employees not getting a paycheck. Do you think there might be chaos in our society if that happened???
Your site ate my post. It thanked me for my comment but never displayed it.
Why?
The theory that markets self-regulate, prior to a crisis, has been disproven. The theory banks can be recapitalized with public finance in order to resume their commercial paper business is about to be disproven, costing the American tax payer a trillion dollars.
The government will have to use its regulatory oversite to insert itself into the daily management of financial institutions if it wants to ensure the financial markets continue to operate. Optimism that capitalist companies will ease their lending practices in a time of uncertainty, if given a publicly financed bailout, is magical thinking doomed to failure for its disregard of capitalist morality.
A complete and total bust is the only way to hurt the fascists
Wouldn't a complete and total bust mean the fascists won? Wouldn't nationalizing the banking system for a few year(one big credit union?) till they can run on their own and then sold back to the private sector hold the fascists at bay? During which time we arrest(or tar and feather as noted above)the fascists...
The Wall Street Journal on the fact that there's no commercial paper crisis for Main Street:
http://online.wsj.com/article/SB122338435340511171.html
"Most of the recent contractions were in commercial paper tied to financial companies in the U.S. and overseas; industrial corporations were less affected though some firms have had to pay higher interest rates to borrow in recent weeks."
"The so-called unsecured commercial paper market for financial companies has contracted to $683 billion from over $835 billion in March this year. Its current size is comparable to what it was in early 2006."
The idea that Main Street is affected by the crisis because "some firms had to pay higher interest rates in recent weeks" is absurd. Looking at those interest rates shows that they were right around where rates were in 2006, just like volume.
"some firms had to pay higher interest rates in recent weeks..."
...while all Americans paid a higher price for bread.
elmo: Wouldn't nationalizing the banking system for a few year(one big credit union?) till they can run on their own and then sold back to the private sector hold the fascists at bay?
Worked for Sweden. Actually no need to nationalize all of them (some were actually well enough run), just take failing ones into receivership.
During which time we arrest(or tar and feather as noted above)the fascists...
Why so wimpy? Whatever happened to the guillotine?
If California can't float short-term bonds--which has to be what RANs really are--then one would have to think we have a capitalization problem, not a fear problem.
We have both. The fear problem is mostly among banks -- they're afraid to engage in interbank lending because of lack of confidence in each others' balance sheets (they're afraid they might be lending to an insolvent bank unable to pay back). In other words, they're afraid of lending to banks that have become severely undercapitalized because of the drop in value of mortgage-related assets.
If you're a bank, and your cash flow is in dire straights because of your inability to get short term loans from other banks (banks rely heavily on short term lending to smooth out their cash flows just like other businesses) you're going to reduce lending activities in general, and/or raise interest rates because of the higher rates you're paying. This is on top of another factor that directly limits the ability of banks to lend: the aforementioned drop in capital (the amount of money the government allows depository institutions to lend is capped as a percentage of capital).
Longer term lending cutbacks are a less pressing issue for corporate America, because you can always put off building that new factory. But if you've got suppliers or your payroll company to pay next Wednesday, lack of ability to borrow short term is a veritable crisis.
I guess the Fed had no choice but to jump into the commercial paper market, but I can't help but thinking they seem to always choose the most expensive and complicated way to do everything. I would imagine they could get similar results more cheaply by simply guaranteeing interbank lending. But what do I know? Maybe the contagion of fear really is spreading so rapidly that banks are actually afraid to lend short term to large, credit-worthy companies uninvolved in real estate.
Why so wimpy? Whatever happened to the guillotine?
I don't see why we can't tar and feather them then haul there asses to the guillotine? I'm totally down with that...
The tar and feathering scene of a royal tea tax collector in HBO's "John Adams" was pretty gruesome. As President W. Bush would say, "violence is hard work."
Check out the story on Wachovia freezing a fund that universities use for short term credit:
http://dealbook.blogs.nytimes.com/2008/10/02/wachovia-limits-fund-access...
This has been a big issue for a lot of schools.
The TED Spread is nickeling down to 355--- which doesn't mean things are getting better, it means the cracks in the glass are spreading out from our fingers and face, from our knees on the windshield, are getting longer and deeper. Somebody, someplace, has done the calculation and knows the approximate place where the 'full faith and credit' of the U.S. government breaks, where we cannot save the world's credit markets the way Iceland can't cover its biggest banks debts.
I'm all for mocking AIG's executive retreat and Fuld's golden parachute, but this ain't about tar and feathers.
Nobody knows what the dynamics of a sustained credit crunch like this will be: is it going to be like an old-fashioned bust after the boom, where a market-clearing price will be found, bold folks with deep pockets will time it right, pick up amazing bargains and we will all move on?
Or are we looking at a global economic engine that has lost the lubrication of easy credit -- and is about to throw a rod?
Cuz when you pierce the engine block, you can't fix it by changing the oil (which you should have done long ago): you have to change the engine.
Tar and feathers won't help that.
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