Oct 6th, 2008 at 11:52 pm
Into The Breach
The most tangible sign of the credit crunch has been the complete drying out of the so-called “commercial paper” market, wherein companies pass out IOU slips (”unsecured debt”) so that their day-to-day operations aren’t shackled by the ups-and-downs of the cash flow cycle. Under the circumstances, it seems natural for the Fed to consider an unprecedented move to step into the breach and start buying commercial paper in order to get the juices flowing here.
Needless to say, this whole topic is pretty far outside my comfort zone. But I wonder — once the Fed gets into this sort of thing, how easy is it to step back out?
95 Responses to “Into The Breach”
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October 7th, 2008 at 12:02 am
Good question, but I think once things stabilize they can raise the price of the lending to encourage private lenders to take over at a lower price.
October 7th, 2008 at 12:05 am
How easy it is to step back out will depend in part on the terms under which the Fed operates.
If there is a transaction cost penalty for using the Fed system … and for commercial paper, it does not have to be very high … then once the debris has stopped crashing down, the best credit risks will very quickly shift back into reliance on a private market … at which point the Fed can start ratcheting up the transaction cost while getting more finicky checking up on the balance sheets of the companies offering the paper, until its a club where nobody who wants to join can gain admittance.
A strange possibility, however, now that the US has shifted to a Continental European style system where investment banking is a branch of commercial banking, is that banks that find themselves in a more liquid position may be the ones to start buying the commercial paper, to grow their revenue base, and banks start playing a larger role in providing short-term corporate credit … as in Continental Europe.
October 7th, 2008 at 12:27 am
But I wonder — once the Fed gets into this sort of thing, how easy is it to step back out?
No harder than backing out if they just bought the banks. A little touchy making the shift, but otherwise not a big deal. It’s running the thing that’s the problem. And keeping the balance sheet from imploding.
They sure are going a long way to avoid taking over Goldman-Sachs, aren’t they?
max
['My my my.']
October 7th, 2008 at 12:31 am
What if they don’t stop?
What’s the downside?
October 7th, 2008 at 12:47 am
“once the Fed gets into this sort of thing, how easy is it to step back out?”
I’m not exactly sure the gist of the question, but the rates that the Federal Reserve will get in that market will likely be very attractive, especially at first, and it will be hard for the government to fight the temptation to keep making money hand over fist like that. All that fun profit-making might conflict with the Fed’s more central roles. I suppose that getting into short-term paper does put the taxpayers’ money at risk, but I don’t see how it’s much more risk than usual. The reason private capital isn’t lending isn’t beause this paper is much more risky, it’s because financial institutions are desperately trying to recapitalize after huge losses and in the midst of fears that more write-downs are still to come. I’m probably missing something, though.
October 7th, 2008 at 12:56 am
If the Fed’s commercial paper data is to be believed, the whole thing is overblown. Sure, financial firms can’t issue commercial paper, and nobody wants asset-backed commercial paper (”assets” frequently means “mortgage bond”), but if there’s an impact on the industrial side, it’s sure not showing up in the data.
October 7th, 2008 at 1:10 am
The Fed, bankrolled by the Treasury is now the lender of last resort for the entire economy. The cost. $198B two weeks ago. $143B last week. $98B this week, so far. Pretty soon it’s going to get expensive.
October 7th, 2008 at 1:12 am
They might as well just wave a magic wand and make it all disappear. Whatever happened to paying for things in cold, hard cash? This credit economy feels largely imaginary, it’s not backed by anything tangible, except trust that someone’s assets are worth what they say they’re worth. How long has the economy been running on trust and is it this way everywhere?
October 7th, 2008 at 1:39 am
What if they don’t stop? What’s the downside?
See Hungarian pengo.
October 7th, 2008 at 3:00 am
Nationally, we can probably expect much of our national debt to be serviced with lumber, minerals, oil, etc., from our national parks (which were put up as collateral when Nixon abolished the gold standard).
The Federal Reserve is a private bank. The dollar is issued to the government as debt. The “government”, i.e., taxpayers aren’t going to get anything out of these deals as they stand.
The top percenters are just getting themselves and their government lackeys (and a few Chinese big-wigs) bailed out so they can convert as many dollars as they can into something of value and leave the country, before the dollar becomes absolutely worthless and the nation gets very angry. Tax payers are the lenders of first and last resort.
What a screwing we get for our investment in government.
October 7th, 2008 at 3:40 am
Matt Yglesias, hard core conservative:
http://theenlighteneddespot.wordpress.com/2008/10/07/matthew-yglesias-radically-conservative-black-supremacist/
October 7th, 2008 at 5:11 am
In about two years, you should be able to purchase a lovely Park Slope brownstone for about 75,000.
October 7th, 2008 at 6:36 am
Re: How long has the economy been running on trust and is it this way everywhere?
Since the Sumerians were building ziggurats and yes, everwyhere.
October 7th, 2008 at 7:47 am
Pretty easily. Commercial Paper has an extremely short due date (by law no more than 270 days). The Fed could just let paper expire and not renew although most companies will roll-over their paper (issue more to pay for old paper). The most sensible thing would be the Fed to buy the paper and once the market is deep enough again to sell the paper on the open market. The problem now is companies like GE (triple A debt rating, the gold standard) can’t issue paper for longer than overnight. A good swath of US companies rely on paper to finance short-term expenditures such as buying inventory, etc. The CP market is one of the first credit markets to shut down (it’s completely unsecured debt, so no one wants to have that in bad times) but it play a pretty important role in our corporate economy.
October 7th, 2008 at 7:54 am
The Fed is trying to be all things to all men. Is it the Fed’s mandate to lend directly to companies? What next? The Fed is going to start issuing credit cards for John Doe? This is getting ridiculous.
October 7th, 2008 at 8:41 am
It’s a huge exaggeration to say that commercial paper is “frozen” or “dried out”. 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.
Look here:
http://www.federalreserve.gov/releases/cp/
http://www.federalreserve.gov/releases/cp/volumestats.htm
October 7th, 2008 at 10:05 am
Whatever happened to paying for things in cold, hard cash?
I know this sounds really strange compared to how a typical person lives, but most businesses are working on short-term credit rather than paying for cash up-front. It makes sense: if you’re a builder, your crew still needs to get paid every 2 weeks, even if the customer isn’t going to pay you until the job is done. Retailers still need to pay their rent and their bills for 12 months out of the year, even though they depend on the sales from the Christmas season to be profitable. Many businesses are engaged in a race between accounts receivable and accounts payable, with a line of credit filling the gap
October 7th, 2008 at 10:54 am
Um, the unsecured debt bit would be an issue for me.
October 7th, 2008 at 4:18 pm
Interesting stats, dcreader. I wonder if the real crisis is that businesses want a lot more more commercial paper than they used to, as opposed to the stuff not being issued anymore. There’s a lot of anecdotal evidence that there’s some kind of problem here.
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