Tuesday, October 7, 2008 at 6:54 am
The Fed gets ready to try another thing it's never tried before
The next bold experiment (or desperate gambit, if you prefer) from the Fed appears to be a plan to start buying commercial paper directly from the companies that issue it. The reason is that the commercial paper market, a key source of short-term funding for big companies, is shrinking rapidly.
The Fed mentioned as sort of an aside to a press release issued first thing Monday morning that it was discussing such a step with Treasury.
Things have moved along a bit since then. Reports the Washington Post:
Last night, the Fed was drawing up plans to set up a special fund that would buy short-term commercial paper. The purchases would benefit banks as well as non-financial companies.
The fund would be financed by a loan from the Fed, and any losses would probably be covered by the Treasury using its new $700 billion bailout package. Fed and Treasury lawyers were hammering out details last night.
The commercial paper market is generally pretty low risk, so the likelihood of taxpayers losing a lot seems slim. Then again, the likelihood of a lot of the things that have happened over the past couple of weeks would have seemed awfully slim a month ago.
The bigger issue may be the Fed and Treasury, which have already become the most important actors in the banking industry, are about to expand beyond it to dole out credit directly to corporate America. As Floyd Norris, who was the first to get the significance of the proposal Monday morning, wrote:
[W]e may soon have the government deciding which companies deserve short-term loans, and at what interest rates. Does this remind anyone else of central planning systems?
Update: The plan is out, and it's called the Commercial Paper Funding Facility (CPFF), which will use a special purpose vehicle (SPV) to "purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers." The press release continues:
The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.
Got that? Also, I have a related post here.
Update 2: Turns out Nouriel Roubini recommended this move last week.
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Tuesday, October 7, 2008 at 9:11 am
Seems too little too late for me. The FED realized too late the mess we are in. What it comes down to is that THE ECONOMY IS MORE POWERFUL THAN THE GOVERNMENT. Yesterday the market dropped below 10,000 for the first time in years. These are some of the reasons I found why this is happening http://www.gotoguy.com/?p=402.
Good luck to everyone and I hope you have CASH on hand.
Tuesday, October 7, 2008 at 9:24 am
Central planning . . . but without the planning part.
Tuesday, October 7, 2008 at 10:18 am
Well put, Curmudgeon, well put!
Tuesday, October 7, 2008 at 12:11 pm
Well we tried the Bush experiment of tax cuts/tax cuts, and deregulation and those didn't work. Shouldn't run that experiment again.
Might as well try this experiment, but THIS time watch it! Any high school lab class knows enough to watch the test tube closely.
Tuesday, October 7, 2008 at 1:01 pm
"The commercial paper market is generally pretty low risk"
If that were true, why is it shrinking rapidly? Someone (being banks and investment firms) must think there is more risk there than before.
Tuesday, October 7, 2008 at 1:45 pm
I'm guessing that the markets for commercial paper are drying up because banks need to conserve cash. Every loan (commercial paper, credit cards, revolving credit, home equity, you name it) takes money away from what they may find themselves suddenly needing to offset a security that has either dropped significantly in value or there is no way to value it at the moment.
Also, I think there is just a general swing toward overcaution, in reaction to the years of little or no caution.
Tuesday, October 7, 2008 at 2:03 pm
This is all part of an elaborate well calculated and executed pyramid scheme. Nothing these people are doing, suggesting or implementing can be trusted because they just stole trillions of dollars. Their plan is not to make things better or fix things because they are gaining by things being broken, something they purposfully created.
Tuesday, October 7, 2008 at 2:23 pm
@Nathan W.: Justin, if I may... There might be more risk at the edges (looks like we're heading into a recession, and you know what happens to companies in recessions), but the much bigger reason for the commercial-paper contraction is investors' aversion to all but the safest of investments. For example, money market mutual funds are huge buyers of commercial paper, and investors in money markets, especially the institutional ones, have either been 1) fleeing altogether, or 2) switching from funds that buy commercial paper to those that only buy Treasuries. Right after the Fed announced its program this morning, the price of Treasuries fell, indicating that people are already willing to stray from the safest-of-the-safe. It's yet another case of fear having overridden fundamentals—and the government stepping in to try to bolster confidence.