Encouraging signs in a credit crunch

Better yields on Treasury bills and a lack of 'blowups' recently give investors encouragement.

from the August 27, 2007 edition

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•"There was a community of investors that was extremely worried," says Carl Tannenbaum, chief economist at LaSalle Bank in Chicago. The rebound in Treasury yields "may be an initial sign that their comfort is being restored."

While all this provides a measure of hope, it's hardly an all-clear signal. "There is still a lack of normal function" in the short-term credit market, Mr. Tannenbaum says.

The challenge was starkly apparent in the Federal Reserve's most recent weekly report on commercial paper, released Aug. 24.

The amount of commercial paper outstanding fell by $90 billion, or about 4 percent, following a similar drop the previous week. Commercial paper includes debts coming due in as much as 270 days, but with 30 days the typical maturity.

In normal times, this weekly report by the Fed isn't a must-read by economists, let alone the general public. But the shift in the past two weeks represents an unusual and sudden freeze-up of activity.

"What's going on now is just pure fear" among investors, says Mr. Wyss.

Companies often need to roll over their short-term borrowing with new commercial paper from month to month, and now many can't do it.

The problem is most acute for financial companies and for firms that borrow using other receivables – such as mortgage loans they've made – as collateral. That segment of the market is called asset-backed commercial paper.

Companies that can't roll over their short-term debt in some cases are finding other means to finance themselves. Lincoln National, an insurance company, sold $300 million in five-year debt so that it could pay off commercial paper that's coming due soon, according to a report in The Philadelphia Inquirer.

The challenge affects some industrial companies as well. "It's going to have some impact" on manufacturing firms, says Brian Bethune, an economist at Global Insight, a forecasting firm in Lexington, Mass.

Some producers of heavy machinery, for example, may find it harder to extend financing to customers. That in turn could mean a modest slowdown in orders.

"If you're not a bank … then you have to fund yourself pretty much through the capital markets," relying on investors willing to extend credit by buying paper, Mr. Bethune explains.

So a key indicator to watch in the weeks ahead will be the Fed's weekly reports – whether the amount of commercial paper outstanding continues to fall at the same rate. "That would be an indication that there still is a severe credit crunch continuing," Bethune says, and that the Fed's move so far "is not getting the job done."

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