Money Market Malaise: Commercial Paper Remains Problematic

There was a decent amount of attention paid to this blog post from the WSJ Marketbeat blog. The sentiment for a cut from the bond and futures markets stems from the concept that what the Fed has done is inadequate to reliquefy the areas that they are targeting. Banks will face significant lending losses, and economic growth will stop, unless the FOMC acts in a major way. We are still waiting (since 5/3) for a permanent injection of liquidity, and we have until Thursday night to see how much good the discount window action has done.

From the “not much good” camp, what good is it if healthy institutions pick up additional excess liquidity at rates above where they could they could borrow unsecured for 5 years in the bond market? Bank of America (BAC) did not need the discount window down by 0.5% in order to take a stake in Countrywide (CFC).

Here’s the current problem. It has been difficult for marginal borrowers to borrow in the Commercial Paper [CP] markets. Even strong names like American Express (AXP) and Lincoln National (LNC) went to the bond market to pay off maturing CP. But if you were a lower rated company, things were worse, like H&R Block (HRB), or GMAC (GMA), things are considerably worse. All they can rely on is pre-existing credit lines. After that, they are dependent on the kindness of strangers.

Now, there is some hint that the troubles in ABCP are becoming more nuanced. Conduits with the highest quality collateral are getting rolled over. But how bad is it for real offenders? It is one of those cases where the ratings agencies are playing catch-up, let us say. Moves from AAA to CCC? Yes. Breathtaking. Sure ruins their ratings migration tables.

For those with time, for a relatively complete article explaining some of the problems that money market funds face from subprime, look here. The risk isn’t the same risk as from asset-backed CP [ABCP] per se, but seems to stem from buying AAA floating rate bonds from CDOs owning tranches of subprime ABS.

Those worrying about the carry trade blowing up can rest for a while. The Bank of Japan decided not to tighten. Japanese lending rates remain low a while longer, and the party goes on. I guess it will take the importation of inflation to make that change.

Beware easy certainties. Just because the Fed cuts does not mean the market will rise, or that if it doesn’t cut, it will fall. On average, it is true the 6 months after a first cut, the market rises, and almost always rises after a full year the first cut.

I previously asked who could benefit from incremental US dollar liquidity. I came up with a few possibilities, but one I did not come up with was Hong Kong, with their link to the US Dollar on one side, and their link to Chinese growth on the other. It is certainly worth a thought.

Full Disclosure: long LNC.