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.''
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Commercial paper is bought by money market funds and mutual funds that invest in short-term debt securities. In asset-backed commercial paper, the cash is used to buy mortgages, bonds, credit card and trade receivables, as well as car loans. Some of the programs are backed by subprime loans. Subprime loans are issued to borrowers with poor credit or high debt.
About 26 percent of asset-backed commercial paper outstanding as of July was used to fund purchases of mortgage- related securities, according to Standard & Poor's. The yield on the highest rated asset-backed paper due in a month reached a six-year high today of 6.18 percent.
Over the last few weeks PIMCOs Bill Gross wrote an article where he basically argued the central problem faced in the markets right now is no one knows where the next problem will pop-up (I believe he used the "where's Waldo" analogy). That perception is starting to bite the markets because no one wants to buy a land mine. As a result, most people are simply shying away from the market altogether.
However, there is no guarantee a rate cut would change this situation. The problem is not about the cost of money. The problem is what will people do with the money. Just because someone has money to spend, it does not mean they are going to spend it on what the market wants them to spend it on. And as recent experience in the T-Bill market shows, people are looking for safety right now. Lowering the fed funds rate will only make that situation worse.
What we have right now is a problem with asset quality and the perception of asset quality. And that won't go away by making it cheaper to buy assets.
