Busch: Where Credit Crunch Is At
The rebound from the absolute depths of despair in the stock market was related to a rumor/FT article/CNBC reporting that the US Federal Reserve is considering a plan for the commercial paper market.
The FT reported yesterday that the Fed is working with the US Treasury on plans for a dramatic move into unsecured lending in the hope that this extreme step could help bring credit markets back to life. "As well as unsecured lending to banks, this could lead to the Fed directly purchasing commercial paper or funding a special purpose vehicle set up to do this."
This new foray is a great example of what I wrote about last week when I said there would be more programs coming to address the frozen credit markets. Why if the Fed considering this? In the money markets now, there is no trust to lend money to anything but Treasuries and overnight only as this is the safest and shortest arrangement for money. Banks are completely overloaded with money, but no lending is occurring except in this structure. To show how insane this is, money is being placed for zero percent. Again, it's not return on money, but return of money.
Program Note: Andy Busch will appear today on CNBC'sStreet Signs .
So in the playbook of what to do during a crisis, we have seen dramatic easing of interest rates, dramatic flooding of liquidity, and a government program to buy securities.....and we're still in lock down of lending. As an example of the coming economic downturn generated from the crisis, SAP's warned yesterday that 3rd quarter revenue would be much lower than expected and blamed the global financial turmoil for a sudden drop in customer orders in September. The reason this is so disturbing is that normally businesses are reluctant to cut IT spending in a downturn as this investment usually leads to productivity gains.
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How do we get out of this spot? Here is where some creativity is needed. (Thank Ja for liberal arts majors!) The above mentioned move into CP is interesting and I would suggest looking at guaranteeing corporate paper rated investment grade out to 3 years to break the logjam at this point. Also, a clearing house for CP wouldn't be a bad idea like the FICC for agency and US Treasury debt.
This would provide assurance that banks/investors would be able to lend past overnight and have confidence they could get their money back. It's all about length of term and re-starting a critical component of funding for corporations. This will allow them to provide vender financing to generate orders for their products. BTW, this also allows farmers to borrow to buy fertilizer to plant crops.
As if on cue, the Fed announces they have created a commercial paper funding facility to provide liquidity to term funding markets and to provide a backstop to US issuers of CP through a "special purpose vehicle". This has sent stocks and Yen carry soaring. It's a good start.....let's see if it holds.
The credit crisis has now moved well beyond lack of liquidity to an extreme lack of confidence in the structure of the financial markets. Longer term, I believe this structure will devolve back to the 1980s where plain vanilla balance sheet lending based off of deposits is the core paradigm. This would explain the competition and fight over Wachovia and their deposits.