Friday, October 31, 2008

Bernanke’s Nightmare: Commercial Paper October 30 2008

This post is a follow up and further elaboration showing the current and historical values for some key interest rates.

These interest rates are for short term (30 day) commercial paper that is typically issued by corporations to “raise needed cash for current transactions”.

A key in reading these rates is to recognize that the AA non-financial is more highly rated than A2/P2 non-financial and that, in general, the AA non-financial tends to track the Federal Reserve’s target rate while the others typically track slightly higher.

Normally, the spread between the weakest quality paper (A2/P2 non-financial) and the highest (AA non-financial) is 15-20 basis points but as of the latest Fed posting, the spread has expanded dramatically to 438 basis points… truly a worrying sign.

The first chart shows the spread between the A2/P2 and AA non-financial while the lower two charts show the how all the short term commercial paper rates have tracked since 1998 and mid-2007 respectively.

Notice that prior to mid-2007, the Federal Reserve had been able to keep these rates fairly tight and in-line with the target rate but now we are seeing significant trouble with the spread now standing at a 472 basis points.

In as sense, the current crisis has effectively erased all the rate cuts Bernanke has made this cycle and even added another 75 basis points.