To put it simply, the commercial paper market works like a credit card for big companies. Some days they have money, and some days they do not. So if they need money Tuesday, but will have money Friday, they'll go to the commercial paper market and borrow some money. Then on Friday they will pay back the money, plus interest. It's usually all very calm and safe -- but when large well-respected companies started failing and the people who had lent them money on the commercial paper market (money market mutual funds, for example) actually lost money on these "safe" investments -- the pool of lenders dried up.
Now the Federal Reserve is stepping in to "inject liquidity" into this market.
Here's how the Federal Reserve explains:
The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.
The fact that the Federal Reserve has resorted to this move, which is of questionable legality and requires the use of a SPV (Special Purpose Vehicle), which is a separate legal entity that does the buying and selling on the Fed's behalf, is well, scary -- and could be a "broader" undertaking than the $700 billion bailout.
Under its plan, the central bank would buy unsecured commercial paper, essentially short-term i.o.u.’s issued by banks, businesses and municipalities.
The market for that kind of debt has all but shut down in the last week, with many major corporations unable to borrow for longer than a day at a time, as banks become more fearful of giving out cash. The volume of such debt totaled about $1.6 trillion as of Oct. 1, down 11 percent from three weeks earlier.
These credit fears persisted over the weekend despite the $700 billion bailout package that Congress approved last week.
The cost of borrowing from banks and corporations remained high on Monday, increased in part by a series of high-profile bank bailouts in Europe, where governments scrambled to save several major lenders from collapse.
The United States government appears to be pressing ahead with other radical efforts to shore up the financial system, even wading into corners of the markets where it has rarely interfered.
One thing seems clear, the "credit crunch" is not going away and it is spreading beyond the mortgage issue.
Press Release [FED]
Fed Announces Plan to Buy Short-Term Debt [NYT]
(AP Photo/Miguel Villagran)
All the money that the banks have lost have _certainly_ not shown up in bank accounts. When the housing market crashed, a lot of home value simply disappeared. People then began to default on their loans, making the value of the loans disappear. The mortgage-backed securities based on these loans then lost their value. And when those mortgage-backed securities lost their value, the folks guaranteeing them took a bath.
To hear you tell it, there's several trillion dollars in bank accounts as a result of home prices falling. I don't think so.
]]>It's funny what happens when an economy collapses - the cost of even the most basic necessities such as food goes up. Eventually there is panic and starvation and no one will be willing to trade their loaf of bread for your useless lump of rock known as gold.
So my advice for anyone wishing to weather this economic collapse is to invest into things that have easily visible value - food, oil, etc rather than things that don't ex. diamonds, gold, platinum.
]]>One of the few times that I'm happy to see sneaky legislative slight-of-hand. Take that, swarm of K Street lobbyists!
]]>I know the public is outraged, but we all need to listen to this, so we can direct our outcries at the right places.
And pay special attention to "stock injections" - this could be the hook taxpayers need to get control of this whole debacle.
]]>Thanks for dumbing it down. For more simplistic financial news check out 'blog.hsh.com.
Thanks for a great post,
Tim
Thanks so much for the heads up.
Link to episode 1 :
]]>@jedthehumanoid: Well the Fed has been removing companies from the Wall St....
]]>@JustThatGuy3: I agree, which is why I cashed in my 401K for 9mm wadcutters!
]]>@agnamus: Is that you, Jim?
]]>@labowski:
CP really isn't like that. It's mainly used to handle true day-to-day expense fluctuations that are, proportionately, a tiny share of overall revenue. The alternative is to have a _huge_ amount of cash on hand, earning very little interest, which is usually a huge waste of money.
]]>Commodity systems would work. If you're happy living in a medieval type economy. But unless you're noble-born, I'm betting that'd be a big, fat, "no".
]]>Gold is highly volatile - it's anything but safe. Look at it this way: what would you have today if you had bought gold and a Dow Jones index fund at varying times:
Since December 1978:
Dow up: 1100%
Gold up: 280%
Since Nov 1979:
Dow Up: 1070%
Gold Up: 18%
Since Dec 1998:
Dow Up: 20%
Gold Up: 195%
As you can see, gold moves around a LOT.
Also, if it all comes "crashing down," your gold coins (assuming that gold's worth anything - since it has no intrinsic value, coin of the realm might well be antibiotics, food, or ammunition) will only be "in your hands" if you have the firepower to keep them there.
]]>@Ouze: The alternative is much worse. Imagine Wal-Mart sending home all 1.1 million of it's employees without pay for three days because they couldn't get a three-day loan in the corporate paper market. Now imagine that wal-mart is just one of the largest employers, and there are many more who rely on corporate paper to do things like payroll. Just for comparison purposes, last week everyone thought the world was ending because payroll employment declined 159,000 in one month (September.)
]]>Also, I totally agree with AgentTuttle the problems with our financial crisis can be boiled down to the absence of a commodity based system.
]]>"is this a commercial version of payday loans?"
No. Payday loans are generally given to people with poor or no credit (if they had good credit,they could get a much better interest rate). Commercial paper is so safe (for the most part) that it is suitable for Money Market Funds . Large, stable companies use it for day to day expenses when they temporarily have more going out for supplies,materials ,payroll and such ,than they have coming in from sales and profits.Generally,the market is self limiting : If a company has too much short term debt floating around out there,the market will demand a higher interest rate that makes it more attractive for the company to issue longer term debt. You probably already own (indirectly ,anyway) commercial paper if you have a money market fund. This and soon- to- mature treasury debt are what makes up the "money market" that keeps the wheels greased.
]]>--*Rob
]]>@Snarkysnake: EXACTLY. A crash in commercial paper would have the most direct consequences for many of us. Just imagine companies like Starbucks or McDonalds suddenly unable to pay their employees. A lot of companies with tight margins operate (briefly) in the red while buying up food and fuel.
]]>I'm not actually saying I think this is the best plan ever by the Fed - I think it sucks. But, what's the administration going to do, really? Sit on their hands and look impotent? The only thing these bail-out measures are accomplishing is political ass-covering, nothing more, and ALL AT YOUR EXPENSE! :)
]]>Today is tuesday!??!!?! Joke fail.
]]>This American Life did a story on this last week. They talk about Commercial Paper and how nervous industry insiders got when it locked up a couple weeks ago. It's worth a listen:
I wonder if Dunder Mifflin can get in on this paper market you speak. With electronic ordering and decreasing costs of national chains they need something to keep them competitive.
]]>@Erwos: While it is true that this may not cause inflation *today* the rise in the debt ceiling and outright printing of money should give anyone shivers.
You can't just continue to monetize at this rate and not cause monetary inflation.
There is also the problem that the companies that most need this new facility are the ones that are most risky. As has been pointed out for weeks CP trading in non-financials has been quite brisk. It's those risky companies that are taking a beating since they refuse to step up and accept the higher interest offers that are out there.
Those companies too risky to be in the CP market are doomed and should declare bankruptcy so that the productive parts can be sold off and the capital markets can concentrate on productive companies.
]]>I could have sworn those got banned in most states...
WTF?!?!?!?!!?!?!!?!
]]>Go public radio! It taught me something.
]]>It's probably a credit to the Fed's previous management that no one comprehends what deflation can do and promptly says inflation anytime they see an economic problem - but there's no excuse for constant inflation scare-mongering, especially when deflation is so much worse.
]]>@ninabi:
Especially when the credit card offers were mailed by banks that have ceased to exist by the time you pull the envelopes out of your mailbox...
Kind of like living by the ocean and getting a flyer advertising swimwear and beach towels when forecasters are warning about the Cat 5 hurricane about to hit the coast.
]]>More like the USSA of China!
(I know it doesn't make any sense but most of my brain cells have taken a vacation from financial matters).
]]>I'll gladly pay you Tuesday for a hamburger today.
]]>The fed is loaning money to companies without regard to credit worthiness because you, the taxpayer, will pay for any losses. This is a bad idea and will only continue to perpetuate a broken system by proping up the hollow shells of banks in an attempt to deny the fact that they are bankrupt.
]]>Liquid commercial paper.
]]>