Fed Looks to Ease Strains in Commercial-Paper Market

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Fed Looks to Ease Strains in Commercial-Paper Market

Post by phongn » 2008-10-07 12:06am

The Wall Street Journal wrote:U.S. officials are examining ways to ease deepening strains in the commercial paper market, which have been hit by an unwillingness among money market investors to hold risky assets.

The move could involve the Federal Reserve making an unusual foray into unsecured lending. The Fed has been flooding financial markets with loans in recent months, but those loans are secured by collateral.

In mid-September, the Fed unveiled a new lending program aimed at helping U.S. banks finance purchases of a kind of commercial paper called asset backed commercial paper, which is secured by collateral such as securities backed by mortgages or car loans.

The move was aimed at stabilizing money market funds that were being forced to dump illiquid or risky holdings as investors redeemed their money.

Some commercial paper brokers lamented that the Fed's backstop for the ABCP market may have at the same time reduced investor demand for unsecured commercial paper issued by many foreign banks and companies. So officials, who see strains in short-term funding markets as a dangerous development, are looking for ways to backstop this market, too.

"It doesn't matter if borrowers are offering to pay 2% or 8% for overnight cash; only the absolute safest, squeaky clean issuers have been able get financing" in the U.S. money markets in the last few weeks, said Ted Byrne, a trader at JM Lummis & Co., a brokerage in New Canaan, Conn.

Fed data showed that the U.S. commercial-paper market shrank a record $94.9 billion in the week ended Oct 1 to $1.61 trillion in outstanding debt, following a $61 billion decline the week before.

Most of the recent contractions were in commercial paper tied to financial companies in the U.S. and overseas; industrial corporations were less affected though some firms have had to pay higher interest rates to borrow in recent weeks.

The so-called unsecured commercial paper market for financial companies has contracted to $683 billion from over $835 billion in March this year. Its current size is comparable to what it was in early 2006.

Financial institutions are grappling with "a sharp pullback by investors, (and) also continues to experience a strong flight-to-liquidity," with lenders parting with cash for shorter and shorter periods, said J.P. Morgan research analysts in a report over the weekend.

Banks are being doubly slammed because they also rely on the market asset-backed commercial paper market, in which short-term debt is issued by vehicles that are financing longer-term holdings such as securities backed by residential mortgages, credit card loans and auto loans.

The U.S. ABCP market had shrunk to $725 billion last week from over $1 trillion at the end of 2006. J.P. Morgan estimates that European issuers account for over half of this market.
The New York Times wrote:WASHINGTON — As pressure built in the credit markets and stocks spiraled lower around the world on Monday, the Federal Reserve was considering a radical new plan to jump-start the engine of the financial system.

Under a proposal being discussed with the Treasury Department, the Fed could buy vast amounts of the unsecured short-term debt that companies rely on to finance their day-to-day activities, according to officials familiar with the discussions. If this were to happen, the central bank would come closer than ever to lending directly to businesses.

While the move would put more taxpayer dollars at risk, it underscores the growing sense of urgency felt by policy makers in a climate where lending has virtually dried up.

The plan was being formulated amid cascading losses in global stock markets, as the banking crisis spread across Europe and investors feared dire consequences for the world economy. The Dow Jones industrial average fell as much as 800 points before a late recovery, finishing down 369.88, below 10,000 points for the first time since 2004.

Even before bankers on Wall Street reached their desks, European stocks were plunging. The Russian stock market dropped 19.1 percent, the biggest decline since the fall of the Soviet Union. Major indexes in London and Frankfurt lost more than 7 percent; stocks in Paris fell by 9 percent. Stocks in Latin America and other emerging economies took their worst collective tumble in a decade.

Volatility reached the highest level in two decades, and oil prices fell below $90 for the first time since February.

The contagion showed no signs of stopping when Asian markets opened Tuesday morning as the Nikkei index of Japanese stocks fell 3 percent and the Hang Seng index of stocks in Hong Kong fell 5 percent.

“There is a growing recognition that not only has the credit crunch refused to be contained, it continues to spread,” said Ed Yardeni, an investment strategist. “It’s gone truly global.”

Investors are worried about what the evaporation of credit will do to an already-weakened global economy.

In the United States, consumers appear to be significantly curbing spending; last month, employers cut more jobs than any month in five years. The $6 decline in oil prices, which settled at $87.81 a barrel, stemmed in part from fears that demand will slacken in the face of a deteriorating economy.

The Fed plan is intended to renew the flow of credit on which the economy depends. Under its plan, the central bank would buy unsecured commercial paper, essentially short-term i.o.u.’s issued by banks, businesses and municipalities.

The market for that kind of debt has all but shut down in the last week, 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.

These credit fears persisted over the weekend despite the $700 billion bailout package that Congress approved last week.

The cost of borrowing from banks and corporations remained high on Monday, increased in part by a series of high-profile bank bailouts in Europe, where governments scrambled to save several major lenders from collapse.

The United States government appears to be pressing ahead with other radical efforts to shore up the financial system, even wading into corners of the markets where it has rarely interfered.

Buying commercial paper could open the Fed to difficult conflicts of interest, because it would be juggling the goals of protecting its investment portfolio with its traditional goals of promoting stable prices and low unemployment.

“The Federal Reserve really would become the buyer of last resort, trying to jump-start the commercial paper market by taking on credit risk,” said Vincent Reinhart, a former top Fed official who worked under Alan Greenspan, a former Fed chairman, and Ben S. Bernanke, the chairman now.

The Federal Reserve has already stretched its resources to the limit by providing hundreds of billions of dollars in short-term loans to banks, Wall Street firms and money market funds.

On Monday, the Fed announced that it would once again redouble one of its key emergency lending programs, increasing the size of its Term Auction Facility to $600 billion, from $300 billion. On top of that, the central bank plans to provide an additional $300 billion to banks to meet their end-of-the-year cash needs.

To pay for its burgeoning responsibilities, the Fed has no choice but to keep printing more money. To prevent that flood of new money from reducing the central bank’s overnight interest rate to zero, the Fed also announced on Monday that it would start paying interest on the excess reserves that banks keep on deposit at the Fed.

Paying interest on reserves allows the central bank to set a floor on interest rates and retain at least some control over monetary policy.

In its announcement on Monday, the Fed said it would pay an interest rate of 1.25 percent —three-quarters of a point below its target of 2 percent for the overnight Federal funds rate.

But the possibility of propping up the vast market for commercial paper could represent an undertaking even broader than the Treasury Department’s plan to buy as much as $700 billion in mortgage-backed securities.

In statements on Monday morning, the Federal Reserve and the Treasury said they were “consulting with market participants on ways to provide additional support for term unsecured funding markets.”

By referring to “unsecured funding markets,” policy makers signaled that they wanted to intervene directly in the credit markets. Officials said on Monday evening that they wanted to finish a plan as quickly as possible, perhaps as early as Tuesday.

But the effort is fraught with legal complexities. Though the Federal Reserve has sweeping power to create money and lend it out, experts said it was normally prohibited from buying assets that could lose money.

One way around that legal limitation would be to provide money to a separate legal entity that would do the buying and investing on the Fed’s behalf. That would be similar to Maiden Lane Funding L.L.C., a special-purpose entity that officials created last spring to hold $29 billion in hard-to-sell securities from Bear Stearns.

But so far, the myriad efforts by government regulators to shore up confidence have seemed to yield little relief among investors, some of whom believed the actions have taken on a haphazard air.

“People are slowly but surely coming to the realization that playing ‘Whack-a-Mole’ with each of these issues as they arise, on an ad hoc basis, doesn’t get the job done,” said Max Bublitz, chief strategist at SCM Advisors, an investment firm in San Francisco.

On Wall Street, Monday was a frightening day for investors — the type of day where a 369-point deficit in the Dow is considered a relief.

A broad sell-off began at the opening bell and intensified throughout the morning. After 2 p.m., the Dow was down a hair over 800 points, worse than the 777-point drop one week earlier.

But around 2:30, investors began to hunt for bargains, sending the Dow briefly back above the 10,000 mark, before finishing the day at 9,955.50. The broader stock market closed down 3.9 percent, as measured by the Standard & Poor’s 500-stock index. Shares of financial firms, manufacturing outfits and industrial companies all fell sharply. The Dow has lost 1,187 points, about 10.7 percent, and the S. & P. almost 13 percent in a week.

The sharp slide on Monday came despite assurances from President Bush that it would “take a while to restore confidence to the financial system.”

“We don’t want to rush into this situation and have the program not be effective.”

Following are the results of Monday’s Treasury auction of 72-day cash management bills and three-month and six-month bills.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by Crayz9000 » 2008-10-07 02:10am

I don't know what to say. I guess one of the other guys was right when he said that the Fed and Treasury would be turning the printing presses up to 11. Their approach to this whole situation is so obviously "let's throw taxpayer money at this until it goes away" that it's nowhere near being funny.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by Edi » 2008-10-07 04:41am

It's absolute fucking insanity.

"The markets have been structured of a house of cards with a lot of unsecured lending and now that it seems to be crashing, let's make the taxpayers pay for it!"

It's simply pouring money down a black hole while devaluing it at the same time and it's not going to solve anything.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by The Kernel » 2008-10-07 08:49am

I'm of two minds about this. On the one hand, the inability of corporations to roll their corporate paper in this lending climate is frightening and must be resolved. Furthermore, these types of loans typically aren't all that high risk despite being unsecured.

On the other hand, I've got this little voice in the back of my head screaming "inflation!" and "abuse!"...

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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by J » 2008-10-07 09:23am

The Kernel wrote:On the other hand, I've got this little voice in the back of my head screaming "inflation!" and "abuse!"...
http://www.federalreserve.gov/releases/h3/Current/

Look under the "Monetary base" column, week of September 24. Inflation is here and now.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by The Kernel » 2008-10-07 10:53am

Edi wrote:It's absolute fucking insanity.

"The markets have been structured of a house of cards with a lot of unsecured lending and now that it seems to be crashing, let's make the taxpayers pay for it!"

It's simply pouring money down a black hole while devaluing it at the same time and it's not going to solve anything.
You don't have a clue what commercial paper is do you?

Let me let you in on something: fear is driving the credit markets right now, not facts. A lot of bad loans were made, so now everyone is hesitant to make ANY loans which is affecting the market for legitimate business loans. Every financial institution uses commercial paper to finance their day-to-day operations, and even though these loans are unsecured they are also very short term and very low risk.

Of course why bother to actually understand something when you can just repeat the same tired bullet points over and over again?
J wrote:http://www.federalreserve.gov/releases/h3/Current/

Look under the "Monetary base" column, week of September 24. Inflation is here and now.
Yeah, that's pretty sobering.

At a guess, I'd say that the Fed has decided that the risk of double digit inflation is worth avoiding a total lockup of the credit markets. Honestly, I'm not sure that they are wrong either--it's the classic "rock and a hard place" situation.

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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by J » 2008-10-07 11:40am

From here

It's the condensed version of what Nouriel Roubini has noted on his site, I'd like to quote that one but it's a paid subscription.
Fed Wants To Sponsor Its Own SIV

In spite of the fact that Citigroup is sitting on $1 trillion in SIVs it does not know what to do with, the Fed wants to start its own SIV. Bear in mind the Fed has never in history made unsecured loans, the Fed has no authority to do so, and Congress just authorized $700 billion to buy mortgages purportedly to bail out housing. Yet remarkably, the Fed is considering making unsecured lending.

Bernanke Theories All Failing

- The Term Auction Facility (TAF) is not working to increase bank to bank lending.
- The Primary Dealer Credit Facility (PDCF) was supposed to prevent more dealers from blowing up. Yet, Lehman went bankrupt anyway and Merrill Lynch had to merge with Bank of America to avoid collapse.
- Slashing interest rates to 2% did not prevent a recession.
- The ABCP MMMF Liquidity Facility may have stopped a run on money markets but it has not done anything to restore confidence in in the ABCP market itself.

Keynesian theory suggests the Fed is in a dreaded "liquidity trap". The reality is there is no such thing as a "liquidity trap", at least in Austrian economic terms. There is no trap, because it is impossible to prevent the liquidation of credit boom malinvestments.

Purging of bad debts must take place before a lasting recovery can begin. The mistake the Fed is making is attempting to force liquidity down the throat of a market that does not need it and cannot use it.

Why Aren't Banks Lending?

- Banks do not have money to lend
- Consumers who want to borrow are not credit worthy
- Consumer spending is 75% of the economy and consumers are tapped out.
- Unemployment is rising
- There is rampant over capacity in every sector but energy
- Banks do not trust each other
- Cancellation of mark to market accounting heightens that sense of mistrust

The problem is not a failure to lend, the main problem is there simply is no pool of real savings to lend. Furthermore, given rampant overcapacity and rising unemployment, there is no reason to lend even if the funding was available.

Robbing taxpayers to the tune of $700 billion does not change the equation.

With that backdrop it's no wonder Bernanke's attempts to free up the credit markets are having the effect of pushing on a string. Should the Fed actually stimulate lending, more money will end up in money heaven as a consequence.

Academic Wonderland

The credit markets are chocking on credit, yet Bernanke is attempting to force more credit down everyone's throats. Logic dictates the solution cannot be the same as the problem.

Trapped in academic wonderland, such simple logic is far too complex for Bernanke to understand. Sadly, we are all forced to watch Bernanke flop about like a fish out of water attempting to solve a solvency problem with ridiculous liquidity schemes like the TAF, PDCF, TSLF, TARP, and the ABCPMMMFLF.
On commercial papers

Look at the chart. Note that non-financial commercial papers are doing just fine. It's the financials which are getting hammered since there is no trust and no transparency in that segment. The new laws which seek to suspend mark to market will make it even worse. Think about it, why would you, or anyone else, lend substantial amounts of money to a company which is lying on its balance books and cash flow, hiding huge losses in the Level 3 drawer, cheating on quarterly and annual reports, and which might go under any time on no notice or get nationalized by Treasury at the drop of a hat? Does it make sense to lend to completely untrustworthy borrowers? I wouldn't lend out a single penny.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by Edi » 2008-10-07 01:47pm

Kernel, the impression I got from that article is that the intention is to make the Fed buy unsecured paper from banks and other similar institutions, which have done nothing but fuck up for a long time. If you have a different opinion, let me know.

I have no problem with unsecured paper as such as long as there are assets to back them up, but trusting the financial sector at all? Sorry, but no thanks. J actually makes it very clear why the situation is what it is and frankly, do you expect the US government and the Fed to do anything effective? I don't.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by The Kernel » 2008-10-07 02:02pm

Edi wrote:Kernel, the impression I got from that article is that the intention is to make the Fed buy unsecured paper from banks and other similar institutions, which have done nothing but fuck up for a long time. If you have a different opinion, let me know.
Actually it appears to be designed to stabilize the entire market for corporate paper. Financial institutions are the hardest hit right now, but it's obviously not going to stay isolated to any specific market. Other sectors are already seeing this propagate with scarcity of loans and high interest rates.
I have no problem with unsecured paper as such as long as there are assets to back them up,
Pardon? Did you just say that you have no problem with unsecured paper as long as there are assets to back them up? Do you know what an unsecured loan even is?
but trusting the financial sector at all? Sorry, but no thanks. J actually makes it very clear why the situation is what it is and frankly, do you expect the US government and the Fed to do anything effective? I don't.
I'll get to J's article in a second.
J wrote:Look at the chart. Note that non-financial commercial papers are doing just fine. It's the financials which are getting hammered since there is no trust and no transparency in that segment. The new laws which seek to suspend mark to market will make it even worse. Think about it, why would you, or anyone else, lend substantial amounts of money to a company which is lying on its balance books and cash flow, hiding huge losses in the Level 3 drawer, cheating on quarterly and annual reports, and which might go under any time on no notice or get nationalized by Treasury at the drop of a hat? Does it make sense to lend to completely untrustworthy borrowers? I wouldn't lend out a single penny.
J, the solitary problem with this article is that it is making broad assumptions about the lending climate without realizing that overall lending is being affected by this no matter how much we want it to be isolated to the financial services business. Whether it's higher rates or tighter credit standards, it's making it more difficult AND more expensive to get credit for business which have nothing to do with real estate, MBSs, CDOs, etc. Like it or not this credit crisis is affecting EVERYONE. This article even acknowledges that, but waves it away at some minor detail.

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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by Admiral Valdemar » 2008-10-07 02:06pm

Edi, an unsecured loan, by definition, has no assets backing it. It's purely based on how stable, financially, the party in question is. If they're downgraded by a ratings agency, then they have problems. Look what happened to RBS' shares this morning after their rating mishap.

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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by J » 2008-10-07 02:15pm

The Kernel wrote:J, the solitary problem with this article is that it is making broad assumptions about the lending climate without realizing that overall lending is being affected by this no matter how much we want it to be isolated to the financial services business. Whether it's higher rates or tighter credit standards, it's making it more difficult AND more expensive to get credit for business which have nothing to do with real estate, MBSs, CDOs, etc. Like it or not this credit crisis is affecting EVERYONE. This article even acknowledges that, but waves it away at some minor detail.
Perhaps you missed the bolded part which reads as follows:
Non-asset backed non-financial commercial paper is trading just fine; it shows no sign of trouble at all. In fact, the coupon being paid - that is, the cost - of non-financial commercial paper is the lowest it has been in five years and is down from just last year by about thirty percent.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by The Kernel » 2008-10-07 02:23pm

J wrote: Perhaps you missed the bolded part which reads as follows:
Non-asset backed non-financial commercial paper is trading just fine; it shows no sign of trouble at all. In fact, the coupon being paid - that is, the cost - of non-financial commercial paper is the lowest it has been in five years and is down from just last year by about thirty percent.
J, not a single part of this blog article is referenced. I'm not going to bother responding to it until I see an actual source/numbers for this.

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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by J » 2008-10-07 04:03pm

FRB Commercial Papers Outstanding

FRB charts of various commercial papers Includes yield curves and historical yield rates.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by Edi » 2008-10-07 04:34pm

Admiral Valdemar wrote:Edi, an unsecured loan, by definition, has no assets backing it. It's purely based on how stable, financially, the party in question is. If they're downgraded by a ratings agency, then they have problems. Look what happened to RBS' shares this morning after their rating mishap.
Yeah, an unsecured loan is supposedly not really backed up by anything but the borrower's say-so. When it comes to pay up and they can't, obviously any assets they have will be seized and the loan taken out of those, since the debt isn't going anywhere. Not having posted collateral != nothing to back up the debt when it comes to a crunch. Therefore someone who does have assets does have some backing for an unsecured loan even if it's not explicitly stated to be so. While someone who has no real assets as such will just cause the lender to incur a total loss.

Obviously, if it comes down to getting the unsecured loan back from somebody's assets, that somebody must be bankrupt first and you may end up eating the whole loss anyway, but there you are.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by The Kernel » 2008-10-07 04:47pm

Edi wrote: Yeah, an unsecured loan is supposedly not really backed up by anything but the borrower's say-so. When it comes to pay up and they can't, obviously any assets they have will be seized and the loan taken out of those, since the debt isn't going anywhere. Not having posted collateral != nothing to back up the debt when it comes to a crunch. Therefore someone who does have assets does have some backing for an unsecured loan even if it's not explicitly stated to be so. While someone who has no real assets as such will just cause the lender to incur a total loss.

Obviously, if it comes down to getting the unsecured loan back from somebody's assets, that somebody must be bankrupt first and you may end up eating the whole loss anyway, but there you are.
Actually total loss on unsecured debt almost always occurs during a bankruptcy for the following reasons:

1) Lien holders get the first crack at assets during a bankruptcy.

2) Unsecured loans are not contingent on having unleveraged assets.

To put it another way, I could have a $100,000 credit limit on my Visa card and a $1,000,000 asset (my house), but if the bank is the mortgage holder on my house, that asset doesn't do a whole lot of good towards my ability to pay back a debt now does it?

Besides, although asset base can be one factor in establishing credit worth, it is not always the primary factor. With companies that have extremely fuzzy asset holdings (this can be anything from exotic derivatives all the way to intellectual property), it is very difficult to establish a credit rating.

So while technically an unsecured credit holder can go after the company assets, it almost always ends up with pennies on the dollar.
J wrote:FRB Commercial Papers Outstanding

FRB charts of various commercial papers Includes yield curves and historical yield rates.
So can you explain what the delineation between asset backed/non-asset backed and financial/non-financial then? I've having a hard time understanding what the criteria is here.

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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by J » 2008-10-07 05:35pm

The Kernel wrote:So can you explain what the delineation between asset backed/non-asset backed and financial/non-financial then? I've having a hard time understanding what the criteria is here.
If the company is listed on the SEC's no shorting list it's a financial, if it isn't it's a non-financial.

With regards to asset backed stuff I'm admitedly a little fuzzy on it as well, but I do know that papers backed by car loans, mortgages, credit cards, student loans, various lease agreements and commercial real estate would all fall into this category. There's likely some others I'm missing but I'm pretty sure it's buried somewhere in the SEC regulations.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by The Kernel » 2008-10-07 07:52pm

J wrote: If the company is listed on the SEC's no shorting list it's a financial, if it isn't it's a non-financial.
Are you absolutely certain about this? The no-short list was not very comprehensive.
With regards to asset backed stuff I'm admitedly a little fuzzy on it as well, but I do know that papers backed by car loans, mortgages, credit cards, student loans, various lease agreements and commercial real estate would all fall into this category. There's likely some others I'm missing but I'm pretty sure it's buried somewhere in the SEC regulations.
Hmmm...so would all corporate loans not be included in this category? And no finer grain is offered for this? It's strange to me that unsecured loans are totally unaffected (which would include credit card debt) but loans backed by assets are going haywire.

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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by aerius » 2008-10-07 08:12pm

The Kernel wrote:
J wrote:If the company is listed on the SEC's no shorting list it's a financial, if it isn't it's a non-financial.
Are you absolutely certain about this? The no-short list was not very comprehensive.
I don't think she's being entirely serious, but the no-shorting list is a pretty good place to start. The way I think of it is that if it makes loans and shuffles money around it's a financial, so mortgage brokers, leasing agencies, car loan & student loan companies, and credit card companies are also financials. There's gotta be a formal definition buried away somewhere, but I sure as hell can't find it.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by J » 2008-10-07 09:28pm

The Kernel wrote:
J wrote:If the company is listed on the SEC's no shorting list it's a financial, if it isn't it's a non-financial.
Are you absolutely certain about this? The no-short list was not very comprehensive.
Well, to be honest I'm not entirely clear myself since deciphering government legalese isn't my forté. If you want to take a crack at it you can read through Section 4(k) of the BHC Act, scroll down to the part which reads (4) ACTIVITIES THAT ARE FINANCIAL IN NATURE and if none of those apply it's non-financial.
Hmmm...so would all corporate loans not be included in this category? And no finer grain is offered for this? It's strange to me that unsecured loans are totally unaffected (which would include credit card debt) but loans backed by assets are going haywire.
Credit card debts are included in ABCPs. As I said I'm kinda fuzzy on what is and isn't an ABCP though I'm certain there must be a formal criteria for it somewhere. As for why they're going haywire, well, a great number of ABCPs were written on mortgages, HELOCs, car loans, credit card loans, and other such assets. The value of said assets are falling off a cliff which means those papers are at risk of defaulting as the cashflow to pay them back is not there anymore since the people who took out the loans on which the ABCPs are based are themselves defaulting.
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Re: Fed Looks to Ease Strains in Commercial-Paper Market

Post by J » 2008-10-15 01:34pm

And an update...
Bloomberg link
Fed Offers GE, Citigroup Commercial Paper Subsidies (Update3)
By Craig Torres and Bryan Keogh

Oct. 15 (Bloomberg) -- The Federal Reserve may subsidize U.S. companies by buying their short-term debt at rates below those demanded by private investors in the $1.6 trillion commercial-paper market.

Fed officials yesterday set the yield they will pay for commercial paper at about 1.1 percentage points less than the average cost for financial companies, weekly central bank data show. Policy makers last week announced emergency plans to buy the securities after the market shrank to a three-year low.

The discount cuts the cost of cash to 2.1 percent from 3.85 percent for General Electric Co.'s financing arm and from 4.6 percent for Citigroup Inc., data compiled by Bloomberg show. One possible unintended consequence: private buyers are shut out.

``The Fed can drive everybody else out of the market'' for buying commercial paper unless market yields drop, said Robert Eisenbeis, chief monetary economist at hedge fund Cumberland Advisors Inc. in Vineland, New Jersey, who used to work at the Atlanta Fed. That could end up ``assuring that markets won't restart,'' he said.

The subsidy underscores officials' concerns over the market, which serves as a checking account for dozens of corporations for paying wages and suppliers, and as a source of financing for consumer credit.

Officials are setting up a special fund to buy the commercial paper, and will start the program on Oct. 27, the central bank said in a statement yesterday. Pacific Investment Management Co. of Newport Beach, California, is in talks to run the plan.

Maximum Amount

A Fed report made public today by Senate Banking Committee Chairman Christopher Dodd showed that the U.S. Treasury will make a $50 billion deposit into the fund as an indication of support. The Fed said the maximum amount of commercial paper that could be funded by the facility is about $1.8 trillion. `

Fed staff officials said last week that because the market's disruption meant some companies could only borrow for short periods, even overnight, the Fed will purchase three-month securities.

The central bank will buy only debt with the top short-term ratings of A-1, F1 and P-1 given by Standard & Poor's, Fitch Ratings and Moody's Investors Service respectively.

To set up the so-called special purpose vehicle that will buy the debt, the central bank will loan to it at the 1.5 percent benchmark federal funds rate, the target for the overnight rate between banks. The yields set by the Fed would offer the fund a return over its cost of financing.

Yesterday, the Fed said it will pay a premium of 1 percentage point over the overnight-index swap rate, which is currently 1.1 percent. It may also charge a further fee of 1 percentage point if the issuer doesn't get a guarantee for its debt or offer some security for it in case of default.

Below Market

The Fed facility would finance the short-term notes at 2.1 percent yields at current rates, or 3.1 percent with the fee.

By comparison, GE Capital Corp. is offering 3.85 percent to issue 90-day paper, about the most all year, Bloomberg data show. Citigroup today posted a rate of 4.6 percent to sell the debt, about the most since Dec. 24. American Express Co. is offering 3.2 percent to issue three-month commercial paper, down from 3.9 percent yesterday.

Financial companies yesterday paid an average of 3.22 percent to issue three-month commercial paper, Fed data show.

GE has no current plans to tap the Fed's program, Keith Sherin, the company's chief financial officer, said in an Oct. 10 conference call. It would use it if conditions became serious enough, and would be eligible to sell a total of $60 billion through its GE Capital unit and $10 billion from the parent company, Sherin said.

Danielle Romero-Apsilos, a Citigroup spokeswoman, declined to comment.

Four-Week Slide

The Fed Board invoked emergency powers to set up the so- called Commercial Paper Funding Facility on Oct. 7.

Companies from newspaper firm Gannett Co. to electricity producer Southern Co. have been forced to tap credit lines or forego raising debt because of the commercial-paper market's disruption.

For asset-backed commercial paper, the Fed will pay 3 percentage points over the OIS rate, a measure of traders' expectations for the Fed's benchmark rate. No fee will be charged. That would amount to a current rate of 4.1 percent. Quoted yields on 90-day asset-backed commercial paper are 4.47 percent.

All borrowers will be required to pay the Fed a registration fee to join the program of 10 basis point of the maximum amount of commercial paper they had outstanding in the period of January to August.

Commercial paper spreads over the three-month OIS swap rate for financial borrowers averaged 0.6 percent in the first eight months of the year. If the market returned to those averages, the Fed facility would result in a penalty rate.

Above `Normal'

The Fed's pricing plan ``would be below a market rate, but it isn't a low rate by any means relative to what was normal,'' says Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. LLC in New York.

The average spread between financial commercial paper rates and the overnight index swap rate is about 2 percentage points. The collapse of Lehman Brothers Holdings Inc. on Sept. 15 eroded confidence in the credit markets.

``Confidence had evaporated about the ability of companies to repay their debts,'' said Crescenzi. ``The uncertainties about exposures kept people from investing. The economy was also collapsing.''
So much for easing the credit lockup. I wonder what they'll think of next to further screw things up...
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The slight variations in spelling and grammar enhance its individual character and beauty and in no way are to be considered flaws or defects


I'm not sure why people choose 'To Love is to Bury' as their wedding song...It's about a murder-suicide
- Margo Timmins


When it becomes serious, you have to lie
- Jean-Claude Juncker

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