You can lead a horse to water but you can’t make it drink. In the same vein, you can ply bankers with hundreds of billions of dollars and insure money fund investors but you cannot force them to part with cash for any reasonable length of time.
On Tuesday, the US Federal Reserve announced it was bypassing the middleman and going straight to corporate America. Its commercial paper funding facility is highly unorthodox – direct lending by the central bank to non-bank borrowers – but it is the right thing to do. The $1,600bn market, which companies use to manage their working capital needs, has almost ceased to function.
Ben Bernanke’s academic background no doubt convinced him of the need to act quickly. A scholar of the Great Depression, he understands that the one-third contraction of money supply between 1929 and 1933 was a primary factor in the economic collapse as banks withdrew credit.
A catastrophe could have come far more quickly this time round. Sound businesses might have had trouble paying their employees, fuelling their delivery vehicles or buying raw materials in coming weeks. The average commercial paper maturity is 36 days, and 28 per cent of the market was coming due this week with 12 per cent next week. The market had already contracted by $215bn in the past three weeks and virtually all new lending was being done overnight.
Unlike the troubled asset relief programme, the CPFF is about solving cash flow problems for sound borrowers rather than scooping up their cast-offs. There is a theoretical risk of loss but it is small, given the rarity of commercial paper defaults. In any case, this is somewhat beside the point, given all the greater risks taxpayers have assumed and the consequences of dithering. By intervening directly, the Fed may persuade the market’s usual lenders to return to the watering hole.
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