The Commercial Paper Squeeze: Why It Hurts

A bond market expert explains how short-term commercial paper lubricates the gears of commerce, and what happens when it folds up

Anthony Crescenzi, chief bond market strategist at New York-based Miller Tabak & Co., has published such books as The Money Market and Investing From the Top Down. In an e-mail exchange with BusinessWeek Senior Editor Suzanne Woolley, Crescenzi discussed the importance of a corner of the financial world that many investors rarely considered until the credit markets started faltering.

What is the function of the commercial paper market, and how important is it?

The commercial paper market is where companies go to raise money for such short-term uses as inventory investment, funding credit cards, and for payrolls. Commercial paper matures within 270 days, but most matures within 30 to 45 days, making it vital for companies to tap the market for money quite often. Commercial paper is sold for "transactions purposes" only, SEC rules state, which for example includes inventory investment. Without commercial paper issuance, $1.7 trillion of short-term credit would dry up, imperiling the ability of companies to produce goods and services, and resulting in big job losses from both a direct and indirect hit.

What is happening in the commercial paper market now?

Over the past two weeks it has become impaired, except for issuers with esteemed credit quality. For those that remain, the interest rate paid has jumped from about 2% to as high as 4.5%. The size of the market has shrunk $110 billion, to $1.7 trillion. Ideally the market slowly increases in size, reflecting growth in the economy.

Is what we are seeing unprecedented?

Last year was actually worse, when in August and September it contracted by $400 billion. These declines in some ways carry more weight than those of a year ago, when the market was purging issuers with mortgage-related exposure. This time, the purge is broad and is impacting issuers with far more predictable cash flows—regular run-of-the-mill companies in need of working capital.

What can corporations do to access funding outside of the commercial paper market?

Corporations could attempt to resort to long-term credit by selling corporate bonds, but it is a market that tends to see just $25 billion of new issues per week—which would make it impossible for the bond market to absorb any meaningful amount of replacement issuance stemming from the commercial paper market.

Do you think the situation in the markets is going to get worse?

I believe the crisis is at its zenith, although history shows that it takes up to three months for financial shocks to exit the systems of nervous investors.

Is it critical for the commercial paper market that Washington passes the financial rescue bill quickly?

It is critical that relief occur swiftly because most commercial paper matures in roughly 30 to 45 days, which means that vast portions of the entire market must be "rolled over," or reissued during this time.

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