naked capitalism

The Times Online tells us that even blue chip companies are having trouble raising money in the commercial paper market. By way of background, commercial paper is an unsecured short term debt (there is another version, asset backed commercial paper, but that’s not the one under discussion right now) that companies and financial firms use on a day to day basis. CP can be as long in maturity as 270 days, but the bulk of the new paper sold is in the 30 to 90 day range.

From the Times:

The paralysis in money markets is feeding through into the wider economy, with blue-chip nonfinancial companies suddenly finding it impossible to borrow short-term, or only at penal rates.

Industrial and commercial companies outside the financial sector have been caught out by the sudden drying-up of investor appetite for commercial paper (CP), the standard way for large companies to borrow for a few days to a few months. Martin O’Donovan, assistant director at the Association of Corporate Treasurers, said that the change in sentiment over the past few days was extraordinary. “Corporate treasurers are surprised by what has been going on since the Lehman collapse. The nervousness about financials has to some extent spilled over into ordinary corporates,” he said.

Demand from investors for blue-chip CP maturing in one to three months had in most cases dried up, Mr O’Donovan said. Corporates were suddenly unable to borrow in the CP market for more than a few days at most. Instead, they were having to call on much more expensive bank borrowing facilities. Given the blowout in Libor, the benchmark for pricing all kinds of loans, blue-chip companies were typically paying a full percentage point more on short-term debt than they were a month ago, Mr O’Donovan said.

Now although this all sounds dramatic, is unambiguously not good, and probably has corporate treasurers plenty anxious, consider:

1. There is no indication that companies are facing a cash shortfall due to the inability to borrow, but that they have had to scramble and pay more and that is disconcerting

2. Even at one percentage point more than last year, short term money is still not very expensive.

I am NOT saying we can go very long with a seized up commercial paper market. The dislocations will grow. These worries about funding probably are leading companies to hold off on discretionary spending. That alone has ramifications.

However, I am beginning to wonder if the markets have gotten into an accidental game of chicken.

Why borrow and lend to your fellow banks if you can get plenty of cheap funding from your friendly central bank? As FT Alphaville said earlier today:

Liquidity is being thrown at the system, but it’s just making things worse.

By pumping in more money central banks aren’t addressing the fundamental concerns of the banks at all. Going cold turkey is a very unpleasant thing, but the solution isn’t more drugs, even if they alleviate short term pain.

In assuming they can rely on central bank money market operations – which will be expanded (as is the case) when the going gets tough – banks are naturally avoiding lending to each other.

Now consider the bailout version of this problem. Yes, the market for bad bank assets wasn’t so hot, but the big reason is not lack of buyers, but unwillingness of banks to accept the lousy realistic prices on offer.

But the government is now moving towards a plan to buy that paper for something closer, maybe a heck of a lot closer, to your price. You now have no incentive to try to unload those assets, so what little trading there was in them has probably gone into a deep freeze.

Even though Mr. Market will win in the long run, I would not bet against banks getting some form of bill passed by Tuesday. To paraphrase James Carville , if you are the bond market, you can intimidate everybody.

Update: Some of the comments lead me to believe I was not as clear as I should have been. I don’t know whether it was being distracted by the debates or having spent so much time on the credit crisis that I am starting to jump over things in my missives.

The CP market not functioning is a big deal. What is surprising is that it is continuing not to function. The big buyers of CP are money market funds (corporate treasurers are also major players). The backstop to the money market funds last week should have taken care of this problem. Clearly it hasn’t.

I am wondering whether this is a communication problem (investors appear to be withdrawing cash from funds and going into Treasuries) or substantive. The program is voluntary, and therefore an investor would have no way of knowing whether his fund was participating unless it announced it had done so or the investor went to the trouble of inquiring. The September 21 announcement promised further details in “coming days” but I see no further press releases. Thus it is not clear that the program is effective yet.

But the money market woes are worsening the general banking woes, as CP issuers are going to their backup lines of credit, which makes demands on banks when they are leery of lending. Thus the apparent worsening of the liquidity crunch may appear to be due to the failure of the bailout bill to pass, but a significant contributor may be lack of clarity on the money fund front.

Any comments appreciated.