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Commercial paper

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Tuesday, Oct 7, 2008

With the federal government announcing that it will intervene in the commercial-paper market—the realm of short-term financing for businesses to maintain operations—Justin Fox links to NYT’s Floyd Norris fretting about all this rampant socialism. He makes a few logical leaps forward and concludes:


So we may soon have the government deciding which companies deserve short-term loans, and at what interest rates. Does this remind anyone else of central planning systems?


This would seem a legitimate fear, except that the government plays favorites with business sectors all the time. That’s how the housing crisis became so acute in the first place, because of the federal support for widespread homeownership that created a fertile field for financial shenanigans.


Central planning isn’t a matter of the commissars in the Politboro issuing five-year plans; it’s a matter of regulatory capture, of skewing the playing field with tax and trade policies and creating a system of crony capitalism. Dean Baker details some of the many recent ways conservatives advanced crony capitalism here; Jamie Galbraith’s The Predator State also looks at how free-market dogma masks the way plutocrats use government to loot the economy. Thomas Frank’s new book explores the theme as well.


But the government’s move to buy commercial paper remains problematic. The ultimate purpose seems to be to prevent credit from drying up for businesses that are otherwise creditworthy but can’t get funds from banks whose capital is tied up in cleaning up its other messes. It used to be that money markets would buy the paper, get a better yield than Treasurys, and pass along the better rate to mutual fund investors. But the chaos in the markets have made this too risky, particularly since the “buck was broken” by a prominent money-market fund last week—investors lost prinicpal in a money market fund. (Money market accounts seem like bank accounts, but they are not; when the buck is broke, in effect it’s as though someone else is withdrawing funds from your savings account.)


The banks themselves can’t get funding, because investors are frightened by the losses creditors suffered in the big-time failures we’ve already witnessed.  Justin Fox explains:


What’s been causing the various bank scares and failures of recent weeks has been an increasing unwillingness of anybody to extend these kinds of loans to banks. An at least partially rational unwillingness, given that senior unsecured creditors took big hits in both the Lehman Brothers bankruptcy and the seizure of Washington Mutual by the FDIC. Now you might argue that this is a healthy capitalistic development, one that will make providers of such credit more discerning in the future. But there’s no way that a creditor could have discerned by looking at the balance sheets of the respective institutions that his money was in dramatically more danger at Lehman and Wamu than at Bear Stearns and Wachovia, where the government acted to protect creditors. It was purely a question of guessing what regulators would do, not weighing the risks of the financial institution.


That’s the problem caused by haphazard bailouts, but America has too many banks to for the government to secure them all, so the sense that lending to American banks in a guessing game will apparently continue, despite the $700 billion Treasury plan to suck up loser mortgage-related assets.


The NYT article about the Fed’s move notes the inevitable conflicts of interest—the Fed basically becomes an investor in markets rather than a market referee dictating the rules of the game. But without moves such as this, the Fed and the Treasury Department seem to fear there would be no game at all.

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