The unprecedented disruptions in the credit markets have caused major problems in the crucial asset-backed commercial-paper market — where firms raise cash through the issuing of short-term debt. The current stagnancy of the commercial-paper market, which provides the short-term fuel that keeps corporate America running, is now widely affecting even creditworthy co.’s. Most of them can no longer borrow money on a short-term basis efficiently. This fact may have been one of the reasons that prompted on Monday – Bill Gross, head of the world’s largest bond fund, to urge the Federal Reserve to take more dramatic steps to jump-start paralyzed credit markets, including direct purchases of commercial paper.
According to Reuters, in his October letter to investors released earlier today – Mr. Gross, wrote:
“A systemic delevering likely requires a systemic solution, which moves beyond cyclical interest rate cuts, liquidity provisions, or even the purchase of subprime mortgage-backed bonds”. The Federal Reserve, continued Gross, “must now act as a clearing house, guaranteeing that institutional transactions are cleared and counterparty obligations are honored”.
So far the U.S. government’s bailout plan hasn’t done much in terms of preventing the funding markets from further deteriorating. Clearly, the activity in commercial paper where co.’s get funds for their day-to-day operations remains still very sluggish. It is obvious the situation requires immediate reversing. The longer it persists, the higher is the risk of the financial system facing more negative complications in raising other financing critical to day-to-day operations.
The commercial paper, usually issued either on an interest-bearing or discount basis, is generally limited to a tenor of no more than 270 days. Investors however, because of weak credit market conditions are only willing to buy short-term paper with 1-7 day maturities and keep shying away from buying debt that matures in a month or more.
Mr. Gross, who oversees more than $800 billion in assets at Pimco, said that credit markets are based on trust and when there is no trust, just as is the case now, markets can freeze up. He also suggested, notes Reuters – that interest rate cuts are now in order since we are experiencing asset deflation, and the threat of headline inflation is long past.