Commercial Paper Market Still in Distress

Yves Smith at Naked Capitalism submits:

Bloomberg tells us that the commercial paper market is shrinking rapidly.
This is a more serious issue than might appear. Commercial paper is an important, if not the most important, source of short-term funding for sizable corporations, mainly because it's cheap and flexible. They can reading adjust the amount outstanding to reflect changes in their need for cash.

When CP matures, and an issuer cannot "roll" it, as in replace it with new CP, he has two choices. If he has the option, he can draw down standby lines of credit with his friendly bank. If he has no, or insufficient, backup lines, he has to get the cash somehow.

Both option 1 and option 2 have costs. Option 1 means he is using higher-cost funding and has limited the company's alternatives for dealing with emergencies. But more important, the demand for cash at banks means it crowds out other bank lending, such as to small businesses.

Option 2 means the company goes into crisis mode, delaying payments to vendors, trying to accelerate payment from customers, possibly even deferring payroll if that is at all an option.

Now on a small scale, these moves would create a few casualties. But on a large scale, as is happening now, both will put a damper on the real economy. They suggest that the 4% GDP growth release for the second quarter may have perilous little relevance now.

From Bloomberg:

The U.S. commercial paper market shrank for a third week, extending the biggest slump in at least seven years, as investors balked at buying short-term debt backed by mortgage assets.

Asset-backed commercial paper, which accounted for half the market, tumbled $59.4 billion to $998 billion in the week ended yesterday, the lowest since December, according to the Federal Reserve. Total short-term debt maturing in 270 days or less fell $62.8 billion to a seasonally adjusted $1.98 trillion.

Commercial paper outstanding has fallen $244.1 billion, or 11 percent, in the past three weeks, suggesting the Fed's Aug. 17 reduction in the discount rate has yet to entice buyers back into the market. More than 20 companies and funds including Cheyne Finance and Thornburg Mortgage Co. failed to sell new paper as investors fled to safer investments.

``I don't think the Fed understands how critical the situation is,'' said Neal Neilinger, co-founder of NSM Capital Management in Greenwich, Connecticut, in an interview today. ``The market is going to overshoot itself and not lend money to people who deserve it.''...

The 11 percent decline over three weeks is the biggest since 2000, according to data compiled by Bloomberg....

In a sign that buyers are still favoring safer assets, an $18 billion auction yesterday for two-year U.S. government debt drew the most demand since 1992.

The sale drew $3.97 for every $1 sold, the most since at least 1992, according to Bloomberg data. For the past 12 sales, the bid-to-cover ratio has averaged $2.77.....