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A puzzling paradox rests at the heart of the credit crisis. There are lenders who have money to loan, and there are people who need to borrow. But the two sides aren't readily meeting up.
The market for commercial paper, large short-term loans, has almost completely frozen. That's because much of its funding comes from money market funds, which have become almost unwilling to lend money.
Money market funds are supposed to be one of the safest places to invest money. You don't expect a high return, but you don't have to worry about losing money. Money market funds control something like $3 trillion dollars, making them giant players. As money market funds turned away from the commercial paper market, the situation turned dire.
Deborah Cunningham, chief investment officer at Federated Investors, explains why her firm had shifted its $280 billion in money market investments away from short-term loans. Cunningham says Federated's decision, but that of the shareholders — the pension funds and local banks that have trusted Federated with their money. "We talk to them on a regular basis, and I've not heard any single one of them ever say that they want more commercial paper," she says, with a laugh. "In fact, it's quite the opposite. They're asking, 'What's your exposure? Are you increasing it or decreasing it? Can you post it so that we can view it on a daily basis?' "
Cunningham says the situation won't change until people regain confidence in the market overall. Part of the fear is rational.
Cathy Roy, an executive with Calvert, is responsible for making sure that the bonds Calvert buys — the loans it makes — get paid back. She manages about $1.5 billion. "We've had things disappear in one day — companies, banks," Roy says. "One day people thought Lehman might be OK, and then they came in on Monday and they had filed for bankruptcy. If you had bought overnight commercial paper on Friday, you would have been out of luck."
Financiers like Cunningham and Roy also have to guard against the herd instinct of their investors. Money market funds have to be prepared to give investors their money back, right away. If they lend too much in the shaky commercial paper market, and those loans aren't repaid right away, then money market investors come up short. "It becomes a sort of a death spiral," says Roy.
Runs on money market funds aren't just hypothetical. Already, investors have pulled $100 billion out of money market accounts since September. The federal government has tried to stopped the bleeding by extending insurance to money market funds. That hasn't spurred money market funds back to the commercial paper market, which is part of the Federal Reserve has itself moved to offer those short-term loans to business.