For a sixth week, the total amount of commercial paper outstanding plunged, falling $61.5 billion to $1.449 trillion in the week ended Wednesday. Three weeks ago, the commercial paper market contracted a record $94.9 billion. Cumulative declines for the six weeks total about $365 billion.
The declines of the past two weeks occurred despite the Federal Reserve having announced on October 7th that it was creating a special purpose vehicle to purchase 90-day commercial paper directly from eligible issuers. The facility backstops the commercial paper market, and market participants are behaving as though it is backed up, judging not from the amount of CP outstanding, but by the decline in commercial paper rates. For example, the 30-day asset-backed commercial paper rate has fallen to 3.28% from last week's peak of 4.99%. The overnight rate has fallen to 2.62% from the 5.50% rate that existed ahead of the Fed's announcement.
The Federal Reserve's October 7th announcement was for the creation of a Commercial Paper Funding Facility (CPFF), which beginning October 27th will purchase directly from eligible issuers 3-month commercial paper. The Fed said at the time that roughly $1.3 trillion of commercial paper would be eligible, a substantial portion of the market. Issuers are likely to test the waters when the facility starts up and the market for term-CP borrowing should liven up. To the extent that issuers find a buyer in the CPFF and the MMIFF (see below), reliance upon bank credit will diminish and reduce strains in the inter-bank market, specifically dollar-based Libor.
It is important to separate the erosion in the CP market that is occurring because of problems in the money market from those occurring in the economy. Companies simply have far less need for working capital now compared to before, because of the contraction in personal and business spending. That said, recent declines in some ways carry more weight than those of a year ago, when the market was purging issuers with mortgage-related exposures. This time the purge is broad and is impacting issuers with far more predictable cash flows--regular run-of-the-mill companies in need of working capital. The declines add to the urgency for fixes to the credit crisis, and support the Federal Reserve's recent actions, the latest of which was the creation of a $540 billion Money Market Investor Funding Facility, which will provide funding to special purpose vehicles that invest in certain money market instruments, including commercial paper.
The commercial paper market had been relatively stable since contracting sharply a year ago and before the middle of September 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 were running well above normal. Continued problems in the commercial paper market would be problematic for the economy, as the commercial paper market is where entities go to raise working capital to produce goods and services. I note in my book, Stigum's Money Market, that companies are required by the Securities and Exchange Commission to issue commercial paper for transactions purposes only, which could include payrolls, inventories, and such.
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 is 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. As I said, 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. It is hoped/expected that the Federal Reserve's CPFF and MMIFF will help stabilize the commercial paper market.
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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."