2008 October 07 Tuesday
Fed To Buy Short Term Commercial Paper

The US Federal Reserve, in a very unusual move, will by the short term debt of the highest ranking companies. These companies are finding it very hard to sell their commercial paper to finance daily operations.

The Fed said it was creating a new entity to buy two types of short-term debt, known as three-month unsecured and asset-backed commercial paper, directly from eligible companies. It hopes to have the program up and running soon, Fed officials said.

Fed officials said they would buy as much of the debt as necessary to get the market functioning again but refused to say how much that might be. They noted that around $1.3 trillion worth of commercial paper would qualify.

That this move should even be seen as necessary illustrates just how serious the credit crisis has become. When highly rated corporations can't borrow money the fear in credit markets is very high.

Available credit for corporations is contracting rapidly. A continuation of this trend would cause a depression.

In the past month, the amount of money outstanding in commercial paper loans has fallen 11% to a seasonally adjusted $1.6 trillion on Oct. 1 from $1.82 trillion on Sept. 10.

The decline in available funding indicates only part of the market's problems, however. Investors have also become unwilling to buy longer-term paper - beyond a week or two - from even companies and financial institutions with top-flight credit ratings.

Big names like GE and AT&T are finding it difficult to borrow.

A virtual funding freeze has affected even top-rated companies such as General Electric, the conglomerate, and AT&T, the telecoms group. Mirrored in Europe, where traders said an unusually high proportion of deals were for overnight borrowing, the freeze has intensified fears about the impact of the credit crunch.

Interbank lending rates are at amazingly high levels as compared to US Treasury bills.

Financing costs are soaring as banks hoard cash after the credit crunch triggered by the U.S. subprime mortgage crisis a year ago. The three-month London interbank offered rate in dollars rose to 4.32 percent from 2.64 percent in March, while the equivalent rate for euros increased to a record 5.38 percent, from 4.74 percent six months ago.

You can watch these measures of risk in the banking system with the USD Libor rate and the TED spread.

The Fed's move lowered interest rates on commercial paper.

The Fed's drastic move had a nearly immediate impact: Yields on top-rated overnight U.S. commercial paper dropped 0.74 percentage points, to 2.94%, according to Bloomberg Financial Markets. And rates on three-month Treasury billsóthe ultimate safe asset to which big investors, like money-market funds, have been flockingórose above 1.0% on Tuesday for the first time in weeks.

Commodity price declines and contracting credit have some worried about deflation.

Prices are already falling in parts of the world economy. Home values dropped more than 10 percent in the U.K. and in the U.S. in the past year. Oil, copper and corn drove commodities toward their biggest weekly decline since at least 1956 on Oct. 3, with the Reuters/Jefferies CRB Index of 19 raw materials tumbling 10.4 percent. The Baltic Dry Index, a measure of commodity shipping costs, has dropped 75 percent since May.

``We are certainly more worried about deflation than inflation,'' says David Owen, chief European economist at Dresdner Kleinwort Group Ltd. in London. Central bankers need to ``get rates down and keep them there for quite some time,'' he says.

So many signs of rapid declines in demand point toward a deep systemic problem. I question the ability of governments to reflate.

Consumer credit is contracting. The contraction is mostly coming from non-credit card credit.

Consumer credit fell by $7.9 billion, the most since statistics began in 1943, to $2.58 trillion, the Fed said today in Washington. In July, credit rose by $5.2 billion, previously reported as a $4.6 billion gain. The Fed's report doesn't cover borrowing secured by real estate.

MasterCard reports a big decline in consumer spending. Some are trying to save in the face of fearful news. Others are spending less due to job losses.

MasterCard SpendingPulse, which measures national retail sales, said a steep drop-off in consumer spending sent its specialty retail sales index plunging 7.7 percent in September compared with last year. In August, the decline was only 4.1 percent compared with the period a year ago.

Gasoline demand in the United States has dropped 9.5% in a year as measured by MasterCard.

American motorists pumped an average of 8.625 million barrels per day in the week ended October 3, down 5 percent from the previous week, MasterCard said in its weekly SpendingPulse report.

Year-on-year, gasoline demand plunged 9.5 percent.

The debate about whether we can avoid a recession is over. Now the question shifts to how deep and how long a recession. The public is rightfully scared. It only makes sense that people and businesses will pull back and try to build up their cash stores.

Share |      By Randall Parker at 2008 October 07 10:41 PM  Economics Credit

JSBolton said at October 8, 2008 6:40 AM:

The government needs to inquire into whether financial jihad is going on, and tell us what they find and soon.
Wouldn't almost any terrorist in the world prefer Obama to get in? Non-rational actors would seem almost certainly to be acting on quite a large scale. Alternatively it could be said that the Obama panic is on. If there is no very large scale financial jihad, the use of extraordinary measures such as these mentioned in the post, as if we had to fight a war in the money markets, do seem excessive, don't they?

Luke Lea said at October 8, 2008 6:13 PM:

It is all very scary and confusing, and I don't claim to understand what is going on. I do have a couple of questions, though.

First, We read that a lot of over-leveraged investment banks and hedge funds are being forced to "de-leverage." How does an institution go about deleveraging exactly? Obviously, it must somehow reduce the ratio of its borrowings to its net value, but how do they go about it? And sense, in the banking system generally, the reserve ratio is directly related to the total money supply, doesn't de-leveraging (which means effectively reducing the reserve ratio of quasi-banking instituions) imply a very substantial reduction in the money supply -- which implies deflation? If so, the Fed might be justified in greatly expanding the money supply in other ways, would it not, in order to head off a repeat of 1929? I would appreciate your thoughts, Randall.

My second question relates to what I have read is to be a settling of accounts on this coming Friday of Lehman's credit default swaps, and how so many major institutions are involved, many of which have no good idea of how much money they may owe (since the market is over the counter and therefore opaque), which is why they are hording cash, to avoid potential bankruptcy in case they cannot meet potential claims against them. (Others say this is over-blown because potential debtors are required to constantly put up collateral as the value of credit default swaps changes.) Do you know anything about this issue?

Randall Parker said at October 8, 2008 8:26 PM:


De-leveraging: The institutions borrowed to buy. They need to sell off their holdings in order to pay back the money they borrowed. They also bought options. Basically leveraged investors control assets worth far more than the amount of money spent to buy the assets.

If someone buys a house with a mortgage they are leveraged in a real estate investment. Leverage is commonplace.

Deleveraging and inflation: Deleveraging decreases demand for the types of assets that were purchased with the leverage. But whether that will cut demand for assets across the board depends on how much damage gets done to the financial system as falling asset prices take down financial institutions. I think the Fed has the power to create demand. The Fed can write checks to buy up the whole country. Deflation seems avoidable. If Congress and the President want the Fed to reflate then the Fed can do that.

What I worry about: As an academic researcher on the Great Depression our current Fed chairman Ben Bernanke claims he found evidence that bank failures wiped out institutional memory of which potential borrowers are lower risk. So perfectly sound borrowers couldn't borrow money to finance their businesses and farms and that is what made the Great Depression deep and long lasting. I'd hate to see so many financial institutions fail that we lose the corporate memory on how the businesses and industries of various borrowers function. Fewer good borrowers would get the credit they need to operate. The economy would therefore shrink.

Settling accounts: the Fed and Treasury were encouraging the investment banks and other financial institutions to figure out in advance of the Lehmann collapse whether, in various deals with Lehmann, Lehmann was just an intermediary between two other parties. For example, Goldman could sell a CDS (or other type of risk or option) to Lehmann and Lehmann could sell the equivalent instrument to Morgan Stanley. If Goldman and Morgan Stanley could know that Lehmann is just in the middle and shift the two sides to be between them without Lehmann as an intermediary then Lehmann's failure wouldn't have to make them claimants on Lehmann or Lehmann a claimant on them.

My guess is you are reading about how to handle some of the claims and liabilities with Lehmann by matching up organizations that could reconstitute their contracts to deal directly with each other without Lehmann in the middle.

averros said at October 9, 2008 2:32 AM:

> The government needs to inquire into whether financial jihad is going on, and tell us what they find and soon.

They know. They won't tell.

Simply because jihadists are them, the unholy alliance of bankers and the government.

> As an academic researcher on the Great Depression our current Fed chairman Ben Bernanke

Yep, he *is* a researcher. He's performing an experiment on how to turn a banking crisis into full-blown Depression.

James Bowery said at October 9, 2008 9:02 AM:

The alternative is to recognize nations as land trusts with the posterity of the founders as the designated beneficiaries. This means dispersal of economic rent directly to the citizens as citizens' dividends -- rather than through political processes that require people to form political armies to fight for their piece of the economic rent stream.

Indeed, the most prominent proposal out there right now for this kind of restructuring is out of the GOP "insider" think-tank: The American Enterprise Institute. It is described in detail by the AEI's Charles Murray in his book "In Our Hands."

It only makes sense to support a structure from the foundation.

Has anyone bothered to call up Charles Murray yet?

tommy said at October 9, 2008 3:17 PM:

Only partially related, but I found the following article via John Ray's blog Dissecting Leftism.

FDR's policies prolonged Depression by 7 years, UCLA economists calculate

The UCLA economists believe that another slump the length of the Great Depression is unlikely unless politicians muck things up. I wouldn't put it beyond them.

Sgt. Joe Friday said at October 9, 2008 4:50 PM:

Ordinarily I don't have much use for Bill O'Reilly - I think he's a pompous, self-important blowhard - but he has said in the past that the powerful protect one another, and I believe that's the case now.

If Obama wins the election, which I expect he will, does that mean John McCain will NOT be a wealthy, influential senator? No. He will be, if anything, more influential, because evryone in DC is scrambling to protect their ass, and see to it that the system they all benefit from doesn't get swept away by the financial meltdown. I am not suggesting violent change will take place, but Bush, McCain, Obama, Pelosi, and all the rest are trying anything they think might work not to stabilize our economy, but to keep the voters from becoming so angry that a wholesale replacement of incumbents doesn't take place. It may be too late for this election cycle, but if economic woes persist you can bet it will not be politics as usual in the 2010 mid-term elections.

Stephen said at October 9, 2008 8:39 PM:

James, you mean that the people should control the means of production?

Rob said at October 12, 2008 4:58 AM:

The institutions borrowed to buy. They need to sell off their holdings in order to pay back the money they borrowed. They also bought options. Basically leveraged investors control assets worth far more than the amount of money spent to buy the assets.

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