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Tuesday, September 30, 2008

Commercial Paper Market

There are a number of different reasons proffered for the bailout, er buy-out, that Congress turned down yesterday. I am not in favor of a bailout in order to save a particular bank or to help particular homeowners - that is not the proper role of the government.

However, most economists agree that there might be a role for the government in the case of market failure, including negative externalities. One such negative externality would be a failure in the commercial paper market - which is where firms go (at least at the moment) to smooth their inflow and outflows.

There are many who discount the concerns over the commercial paper market (and I admit to not knowing enough about the market to scoff) yet I haven't seen too much discussion or data depicting the market. The Fed has lots of data on the CP market, as it turns out, and here is a set of time series plots for four series of CP issuance: 1-4 day financials, 5-9 day financials, and 1-4 day asset backed and 5-9 day asset backed.

Check out the spike in the 1-4 day asset backed issuances. Is this a symptom of a larger problem (as has been threatened elsewhere) that lenders are not interested in going for longer than 1-4 days, requiring firms to repeatedly enter the short-term debt market?

Why is this a problem? Two immediate reasons: first companies who borrow are likely borrowing less in each transaction thereby making it more difficult for them to engage in larger-value projects and second it increases the transaction costs. A third problem is that there is a chance that the market might sieze in the future leaving firms without the ability to use this channel to obtain short-term funding.

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