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Breakdown of our modern day banking system
For most readers, the commercial paper market is something you don't think about.
But it is the lifeblood of business.
We have seen this market drop by almost 30% in a year and by 10% in just the last three weeks!
I simply cannot overstate how serious this is.
John Mauldin, The Curve in the Road, 3/10 2008
As I have said repeatedly for months, the problem is that financial institutions are having to deleverage. They have massive losses and simply have to raise capital in order to survive.
GE is an AAA-rated company. Yet they had to pay Warren Buffett 10% to get $5 billion, plus in-the-money warrants worth at least another 10%. Buffett is likely to double his money on this deal over 4-5 years. A short while ago, GE could get short-term commercial paper for a few percentage points. That difference is going to significantly impact GE's bottom line. But they had no real choice. They took the money.
As did Goldman Sachs. Yet another Buffett $5 billion preferred-share purchase (with more warrants) at a rate that even Goldman will find it hard to make money on. But they had to raise capital quickly, and they had little choice.
Rolf Englund:
Note the article below, written in December 2007
What we are witnessing is essentially the breakdown of our modern day banking system, a complex of levered lending so hard to understand
that Fed Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.
Bill Gross, December 2007
My PIMCO colleague, Paul McCulley, has labelled it the "Shadow Banking System" because it has lain hidden for years—untouched by regulation—yet free to magically and mystically create and then package subprime mortgages into a host of three-letter conduits that only Wall Street wizards could explain.
Aren't our central bankers coming to the rescue with lower interest rates and doesn't Treasury Secretary Paulson finally have a plan to steady Citibank and friends with a "Super" SIV as well as a bailout plan to fix subprime yields and keep homeowners in their homes as opposed to on the streets?
Financial conduits supported by a trillion dollars of asset-backed commercial paper were constructed on the basis of AAA ratings that whispered—nay shouted—that these investments could never fail: no skim, just crème de la crème. Now, as the subprimes undermine these structures and the confidence in them, it is a stretch of the imagination to suggest that 75 basis points of interest rate cuts by the Fed will bring back the love.
Credit contraction, with its inevitable companion of asset destruction, is spreading with the speed of an infectious bacterial disease.
The average real short-term rate using this methodology over the past 8 years has been 1½%. Commonsensically, this 1½% real rate is the neutral rate that has pumped life into our new finance-based economy with its complicated shadow banking system.