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David Murphy makes me weep
He is a loyal MR reader, but that doesn't mean he always carries good news:
My question:
When the Fed backstops the Commercial Paper market by entering it and offering a "risk free" counterparty to companies, is it crowding out private lending? I also feel like the same could be true of the Treasury. If the Treasury offers to buy the toxic MBS on the books of private companies, they lose all incentive to deal with private counterparties that are not risk free...I know that the government is trying to encourage credit to flow. In some way it seems like they are impairing the flow by making markets on risk free capital.
Boo hoo! The ideal, of course, is that the people who need riskless assets can hold riskless assets and pass their funds along to those who can profitably lend funds out to riskier borrowers. That's not where we are right now. To put this more concretely, if the Fed is not buying or backstopping your commercial paper (and they're not touching mine), maybe now it's harder to make your way in the marketplace.
David, by the way, poses the thought experiment of ceasing to issue T-Bills but suggests that might bring Armageddon.
Posted by Tyler Cowen on October 7, 2008 at 07:51 PM in Economics | Permalink
Comments
or alternatively, the fed (and other central banks) end up as de facto clearing houses for the money markets & therfore remove the distrust that is the primary cause of the current spikes in lending rates...
Posted by: nick at Oct 7, 2008 8:21:00 PM
The Fed is hardly crowding out private lending. The banks are reluctant to loan now because they're afraid of the cp sellers drawing down large backup lines of credit because of they can't roll over cp. If the fed steps in and it becomes clear that the banks won't have to lend, the banks' money is freed up to loan elsewhere.
Posted by: adam at Oct 7, 2008 8:36:23 PM
I assure you that Treasury's intervention into the MBS market has killed/stalled at least 2 relatively mature deals.
I believe the Fed's intervention into short term credit will retard the Great Deleveraging and slow (but not stop) progress into our new era of traditional interest rates.
I sometimes think that if we had left Iraq after capturing Hussein, the amount of blood spilled would have been the same but telescoped into a shorter period. And that might have been better.
Posted by: Bababooey at Oct 7, 2008 8:47:13 PM
Not on net.
Posted by: Frank at Oct 7, 2008 9:01:48 PM
And the market was down how much? With each massive market intervention, the desired effect seems harder to achieve; the law of diminishing returns.
Posted by: Patrick at Oct 7, 2008 9:30:32 PM
I don't see why the Fed has to actually buy CP? Why can't it just offer to insure the CP of issuers for a few months? That seems less likely to cause problems.
Posted by: srp at Oct 7, 2008 10:01:30 PM
The people I see getting screwed are the companies that have OK but not great creditworthiness. The Fed will buy CP from the people with toxic ratings, anyone with cash will be buying A-1 rated CP, but companies would be apprehensive about stuff with OK ratings.
So private companies will buy up the good stuff, the Fed will buy up the bad stuff, and the guys in the middle are left holding the bag.
At least I am assuming the Fed is only buying CP from companies that are big credit risks.
Posted by: pants at Oct 7, 2008 11:33:38 PM
pants, the reports I read indicated that the Fed was only buying A1/P1 paper.
It isn't clear to me whether the Fed's program also covers tax-exempt VRDOs, but, if it does, then the Fed is potentially supporting Mr. Cowen's employer, despite his penultimate sentence.
Posted by: y81 at Oct 7, 2008 11:42:25 PM
This has been a lot like watching a train crash in slow motion. There's nothing you can do to stop it and the momentum clearly signifies the magnitude of the calamity....
Posted by: Jeff C at Oct 7, 2008 11:51:14 PM
y81-
doh. thank you for clarifying that.
Posted by: pants at Oct 7, 2008 11:59:13 PM
An now McCain wants to spend $300 billion more on homeowner mortgage buyouts. Hey, after the first trillion, a few hundred billion more is easy! Maybe Palin will get that bridge to nowhere for Alaska...
Posted by: Mr. Econotarian at Oct 8, 2008 1:19:00 AM
A majority of businesses have been increasing cash reserves for the last year. Certainly the healthy companies. The Fed could sell bonds (heck call them Recovery Bonds) to these companies, offering attractive tax free returns.
The Fed interest rate would be below the current Libor rate. Offering a 20 year at 5% tax free would invite a lot of takers including some international firms with US operations. The Fed could then lend the money to states (California before it goes into default), the SBA, or directly to commercial banks if they pledge to loan it out quickly.
Limit the issue to a trillion dollars. Minimum of $250,000 per bond.
On net, would that help or hurt the economy? Would it hurt states and governments that currently sell tax free bonds? Would it increase liquidity in the economy at the lowest cost to the government? Would servicing the debt reduce future government expenditures, increase taxes, or gradually increase the national deficit? Is the risk of crowding out that big a risk in the current market?
Posted by: DanC at Oct 8, 2008 2:13:40 AM
Some data some of your readers might be interested in:
http://www.iq.harvard.edu/blog/sss/archives/2008/10/dol_visa_data_r.shtml
Posted by: Simon at Oct 8, 2008 4:55:41 AM
Some of these posts on the economy seem to be very biased, and not in a libertarian sense. Is Tyler trying to start a new political group?
Posted by: brainwarped at Oct 8, 2008 5:38:50 AM
When the Fed backstops the Commercial Paper market by entering it and offering a "risk free" counterparty to companies, is it crowding out private lending?
This is a similar theme to what has happened and is happening in Europe. When a bank gets in trouble, and the government steps in to guarantee its deposits, everyone scrambles to move their cash to the guaranteed bank. This causes five otherwise solvent banks to fail. Lather, rinse, repeat. Eventually, you're guaranteeing the entire banking system, your currency loses half its value, and you're negotiating $5 billion loans from the Russian mafia.
Posted by: Keith at Oct 8, 2008 6:26:33 AM
Haven't local governments been having finacial problems pretty much the entire decade? And being dependent on property taxes, doesn't that make their revenue streams very risky?
Posted by: aaron at Oct 8, 2008 7:02:37 AM
Beyond the technical aspects, which I've been wondering about as well, why are they doing this at all? They should just be concerned about bank solvency. At what point along the way did they forget that mothering the entire economy isn't their job?
Posted by: Andrew at Oct 8, 2008 7:17:50 AM
Maybe the Fed will act as a conduit -- buying CP, then reselling (with Fed backing) CP to (say) money market firms, making a slight profit on the transaction.
This sounds pretty much like "insuring", but may have the added benefit of quickly allowing money market funds with "government" in their title to buy this stuff without changing their charters.
Under other circumstances, the reliance on the rating agencies (who screwed up so badly before) for determining quality would be humorous. Not laughing at the moment.
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