Fed Considers Buying Commercial Paper The Fed and Treasury is considerig entering the commercial paper market, made up of unsecured corporate IOUs extended over a short period of time. We examine just how risky the unprecedented move is.

Fed Considers Buying Commercial Paper

Mitchell Hartman explains the risks of commercial paper to Alex Chadwick on 'Day to Day.'

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The Fed and Treasury is considerig entering the commercial paper market, made up of unsecured corporate IOUs extended over a short period of time. We examine just how risky the unprecedented move is.

ALEX CHADWICK, host:

From NPR News, it's Day to Day. The Federal Reserve and the U.S. Treasury busy again today in the U.S. financial system. The Fed is going to buy up a lot of short term debt. Marketplace's Mitchell Hartman is with us to explain. Mitch, exactly what is the Fed doing?

MITCHELL HARTMAN: Well, the Federal Reserve is taking a number of steps to try to unplug the credit markets. Basically, this is all to help banks to lend to each other and then get banks and investors both lending short term money again to businesses so that they can do basic things like make payroll, you know, and stock their shelves. And now comes the arcane part. What the Fed is doing is actually changing a bunch of rules and regulations, letting banks juggle their balance sheets, and also just plain pumping more money into the system.

CHADWICK: And why does the Fed thinks it needs to start buying this commercial paper? Well, give me an example first of how they're going to do this.

HARTMAN: Well, for the first time, banks will be paid interest on reserved deposits they keep with the Fed. The Fed's also increasing something called the term auction facility. Basically, it'll encourage banks to lend to each other. And then, the most important, the Fed will wade into what's called the commercial paper market. It will lend money directly to companies - that's never happened before - that can't get short term credit right now.

CHADWICK: Right. And that's, this is it, why start buying commercial paper now?

HARTMAN: Well, commercial paper is basically an IOU. It's what healthy businesses sell to fund their basic operations. So, they're buying supplies, and they're getting paid by customers. And on a day-to-day basis, they need some cash in the bank to pay out while they're waiting for money to come in. Now, ordinarily, investors buy this commercial paper. It's considered an extremely safe investment. But they haven't been buying because everyone's so frightened. So now, the Fed will do it, and they'll try to encourage others to jump back into the market as well. I asked Gus Faucher, he's director of macroeconomics at Moody's Economy.com, to explain why this is so important right now.

Mr. GUS FAUCHER (Macroeconomics Director, Moody's Economy.com): Essentially, that commercial paper market has pretty much dried up. Interest rates are very high, and so what the Fed is doing is - they're saying they're going to step in, and they're going to buy some of that commercial paper to make it so that these businesses can go out and borrow in the short term, so that they can meet their payrolls, so that they can build their inventories, and so that the economy won't grind to a halt.

CHADWICK: Mitchell, what about the risk factors? If this commercial paper isn't selling elsewhere, is there a risk in this?

HARTMAN: Well, you know, like a lot of these actions that are putting the Treasury's money on the line, it could be at least a little risky. I mean, the Fed is going to be lending money to a business for a week, possibly as much as three months. The business may or may not need to put up any assets to secure the loan. And Faucher told me, yes, sure, the business could go bankrupt, but, you know, these are generally loans to stable, well established, profitable businesses. They're not having financial problems. The financial system is having the problems, and unless the whole system spirals downward and out of control, most of them will pay back the money on time and probably with a little interest to boot.

CHADWICK: Thank you. Mitchell Hartman of public radio's daily business show, Marketplace.

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