Sunday, October 12, 2008
According to the Federal Reserve, commercial paper "consists of short-term, promissary notes issued primarily by corporations. Maturities range up to 270 days but average about 30 days. Many companies use commercial paper to raise cash needed for current transactions, and many find it to be a lower-cost alternative to bank loans." Because these companies (or banks and muncipalities, which also issue commercial paper) generally have excellent credit ratings, much of the paper is issued without collateral being pledged, and is regarded as being extremely safe, and therefore attractive to lenders. Commercial paper is sometimes described as the lubricant that keeps modern economies moving, and the amount of commercial paper issued has increased rapidly in recent years. But as the credit crisis took hold in 2007 and deepened in 2008, the commercial paper market began to dry up. In October 2008, the market for that kind of debt all but shut down, with many major corporations unable to borrow for longer than a day at a time, as banks become more fearful of giving out cash. The volume of such debt totaled about $1.6 trillion as of Oct. 1, down 11 percent from three weeks earlier. In response, the Federal Reserve on Oct. 7 announced a radical plan to buy large amounts of the notes directly in the hope of restoring liquidity to the commercial paper market and thereby to the credit markets at large. The purchases, to be conducted through a newly created Commercial Paper Funding Facility, would put large amounts of taxpayer money at risk, but reflect the Fed's dire assessment of the threat to the economy.