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Crescenzi: A Worrisome Chill in Commercial Paper

There has been no issuance of corporate bonds this week, a rare event. Typical issuance is over $20 billion per week.

In addition, the total amount of commercial paper outstanding fell by $52.1 billion in the week ended September 17th to $1.763 billion, the largest weekly decline since last December. The drop reflects the seizing up of the credit market that has occurred this week and withdrawals of monies from money market funds. The commercial paper market has been relatively stable since contracting sharply a year ago and in recent weeks had seen strong increases in the total amounts outstanding, so this latest decline marks an abrupt shift.

Reflecting the drying up of credit availability in the commercial paper market, commercial paper rates have surged. For example, the 7-day rate for asset-backed commercial paper has jumped to 4.50% from the roughly 2.5% rate that prevailed over the past few months. A continuation of this trend would be problematic for the economy, as the commercial paper market is where entities go to raise working capital to produce goods and services.

The total amount of commercial paper outstanding peaked in July 2007 at $2.22 trillion before contracting abruptly to about $1.9 trillion a month later and $1.8 trillion two months later. Conditions had been relatively tranquil since then, which is not surprising for the commercial paper market, a Darwinian market that purges weak issuers in rapid fashion, as evidenced by the fact that there have been only 7 defaults in the commercial paper market since Penn Central defaulted on its paper in 1970.

Issuers with mortgage-related exposures have been pushed out of the market, which is what makes this latest round of seizing up worrying, because the issuers that remain are considered far more stable entities with more predictable cash flows.

These data provide all the more justification for the Federal Reserve's policy response to recent events and for a further enlargement of the Fed's balance sheet, which will likely occur next through the paying of interest on bank reserves, a strategy that lets the Fed pump boatloads of money into the financial system without repercussion on the fed funds rate. (For more on Fed moves, see video)

It also makes more imperative that the Treasury Department purchase mortgage-backed securities to both remove unwanted assets from the Street and help get at the core of the financial crisis, home prices.

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Tony Crescenzi
Tony Crescenzi

Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."