During the World War II era, the United States got rid of the pesky Bretton-Woods system and started financing the nation by printing extra money. The Fed, by buying unsecured commercial paper, is bringing those days back.
Commercial paper–a type of unsecured, cheap, short-term debt that doesn’t have to be registered with the SEC–is indispensable for some businesses to finance their operations, including rent and payroll.
The commercial paper market has, in recent weeks, run low, threatening to choke business operations. From the Wall Street Journal:
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.
By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, (The Fed) should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.
The Fed today created something called the Commercial Paper Funding Facility (CPFF), which will use a special purpose vehicle (SPV) to purchase commercial paper from issuers. The commercial paper will be fully financed and secured. The Fed in New York will get a “special deposit” to support the CPFF.
The Treasury believes that without this action, financial markets and the economy will be “substantially disrupted.”
Some people are acting surprised, but about a week ago, this WSJ published this little snippet of foreshadowing:
Standard & Poor’s announced the launch of a U.S. commercial paper index, a new measure designed to provide a benchmark and more transparency for the U.S. commercial paper market.
The index, the first of its kind to be offered by a major index provider, comes as companies have been scaling back their use of the commercial paper market, fearing they won’t be able to raise cash for everyday activities like buying inventory or paying staff if the fragile market falls apart.
This is right in line with the bailout plan’s mission to increase transparency.
A couple of observations:
-On the one hand, this move doesn’t seem risky, because commercial paper gets paid back short-term. And in a dry credit market, companies need somewhere to leverage themselves. If not banks, why not the government?
-On the other hand, what safeguards does the Treasury have in place that businesses will only use its paper it to finance their operations temporarily? Eventually, a good business should be solvent enough not to have to rely on them in the long-rin.
-The state of California should be happy with the move.
What do you think of the Fed’s move to buy up commercial paper?