Commercial Paper Spread Unprecedented, Consequences Go Beyond Financial Sector

Right now the commercial paper market is in an unprecedented seizure. Similar to the TED spread and the “Panic Button” indicator, the spread between the short term high quality and poor quality commercial paper is gone off the charts:

Source: Federal Reserve

If you have scoffed at hearing experts use superlatives, then this chart should bring you to a new found realization that no superlative would do justice.

The consequences go beyond the financial industry causing even sound businesses to have tremendous difficulty meeting cash flow demands. There is always a spread but this is more than just fear due to counter party risk. This is choking off the very life blood of the economy: liquidity.

People are selling their money market funds, which causes the funds to sell to meet the redemptions. Unfortunately, some of their assets are worth less but most importantly, there just isn’t enough liquidity.

The Treasury’s $700 Billion bailout plan also includes an “insurance” scheme to guarantee the value of all money market mutual funds similar to the government’s guarantee on funds in bank deposits (FDIC). Of course, this causes even more pain for the banks because the money market funds pay much higher interest and because of this new guarantee are equal in risk to bank deposits that hardly pay any interest. Furthermore, the FDIC protection only covers $100,000 while this new guarantee is unlimited.

When you consider the magnitude of money market funds in the US, you realize that this is a huge issue which has received much less attention than it deserves.

Comments

[MarvinMBA:]

This shows how scared the market is that we could be facing a rash of defaults/bankruptcies of second and third tier companies. I believe that some of its justified but the fear factor is in there anyway...I suppose with the collapse of our brokerage/banking system it should be expected. Nevertheless, the investing public is demanding a premium for any invested funds...do you blame them considering the supposed risk and recent inflation thats out of control...demand more is what I say.

2008 Sep 22 11:05 AM