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Even a safe bet is harder to find

Kai Ryssdal Aug 16, 2007

Even a safe bet is harder to find

Kai Ryssdal Aug 16, 2007


Kai Ryssdal: The other notion that trickled through the markets today, aside from that thing Bob mentioned about the Fed having effectively cut rates already, was worries about something called commercial paper.

And when we say paper here, we really mean money. Short-term bonds that companies float to run their operations. Commercial paper’s usually a pretty safe bet. But today’s credit market is getting so risky that even that’s getting harder to come by.

John Lonski is the chief economist at Moody’s. Mr. Lonski, welcome to the program.

John Lonski: Thank you.

Ryssdal: Lay it out for me as simply as you can how this works and what the risks are — whether perceived or real.

Lonski: Companies can borrow money short-term, either in the commercial paper market or for banks. Often, it is cheaper for companies of the highest credit quality to borrow in the commercial paper market.

Ryssdal: That is, companies issuing their own bonds, or IOU’s, to raise cash.

Lonski: Exactly.

Ryssdal: So these are important day-to-day sources of money that these guys need.

Lonski: That’s so true. It’s an important means that major corporations use for the purpose of financing the build-up of inventories and other short-term expenditures. Lately, we find the creditors have become more cautious. And as a result, some companies have been forced out of the commercial paper market, and instead have to rely on somewhat more expensive bank loans.

Ryssdal: Well, make it all make sense for me, then. What’s going on in the stock market today? How is that influenced by the commercial paper drop, and what does it tell us about the future?

Lonski: Well, what we’re stating is that total commercial paper outstanding declined by more than $90 billion.

Ryssdal: Companies weren’t issuing the debt, right?

Lonski: Yeah, they were perhaps forced to turn elsewhere to secure short-term credit. Still, a drop of that magnitude is rare. In fact, last week’s was a record-breaking plunge. Last time we had a contraction of commercial paper comparable in size to what is occuring today was in January 2001. And despite the Fed’s best efforts, a recession would still get under way by March 2001.

Ryssdal: Here’s the $64 million question, Mr. Lonski: How long is it gonna take for either the market to correct itself or for some kind of more rational expectation of credit risk to take hold out there?

Lonski: Well, one means of restoring confidence in commercial paper would be through a reduction in the Federal funds rate.

Ryssdal: Which is, of course, the rate that the Federal Reserve controls.

Lonski: Correct, correct. As the Federal Reserve cuts the Fed funds rate, that reduces the cost of funds for financial institutions. And in turn. financial institutions tend to be more willing to take on more risk.

Ryssdal: Rank commercial paper for me. On your list of one of the things you look for for trouble in the economy. I mean, you’ve been studying the American economy a long time. How important is this?

Lonski: It’s very important. It is a valuable barometer of the willingness of major sources of credit to make funds available to businesses. And if this condition persists long enough, the economy could stall, or worse.

Ryssdal: John Lonski is the chief economist at Moody’s Investors Service. Mr. Lonski, thank you so much for your explanations and your definitions.

Lonski: Thank you.

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