Sunday, August 30, 2009

Commercial Paper during the Crisis.

In a comment on the Austrian Economics blog, economist Barkely Rosser wrote:

"The Minn Fed report in fact does show portions of the credit market in a state of major collapse, particularly the crucial commercial paper market."

When you look at disaggregated commercial paper, you will see that high quality, nonfinancial commercial paper was fine. ATT could continue to fund its operations with commercial paper if it wanted, but commercial lending by ordinary banks was expanding during the period as well.

The shadow banking system collapsed. And commercial paper were the "deposits" of that sector and CDOs were their "loans." The collapse showed up in asset backed and financial commercial paper statistics.

The regular banking system continued to operate, presumably because of deposit insurance.
As far as monetary disequilibrium was involved, the key was to expand the quantity of liabilities of the regular banking system to meet the demand of those who were switching away from commercial paper to the FDIC insured deposits they now preferred.

As far as credit markets are concerned, the key was for ordinary banks to fund the loans they originate with their FDIC insured deposits rather than sell them to investment banks who would securitize them, and hold many of them funded by issuing financial and asset backed commercial paper.

But no longer passing these funds through Wall Street was very bad for the Wall Street firms. And while I think the monetary disequilibrium could have been avoided, that is, monetary liabilities of the ordinary banking system expand with demand, the shift in credit markets would have been slower because of capital requirements, both whatever banks think they really would need and the legal requirements.

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