Fed Begins Buying Short-Term Debt

The Federal Reserve yesterday began buying short-term debt from banks and companies as a way to make it easier for corporate America to borrow cash to cover day-to-day operations.

General Electric, the biggest U.S. issuer of commercial paper, said it availed itself of the Federal Reserve's new short-term funding facility. American Express also has said it would register to borrow from the Fed.

The short-term debt is known in the financial world as commercial paper, which companies and banks sell to investors for as little as a week or as long as three months to generate a predictable source of cash while they wait for revenue to roll in.

The demand for commercial paper had dried up following last month's bankruptcy of Lehman Brothers, putting additional pressure on corporations that were already wheezing from an economic slowdown.

The government's intervention in the credit markets showed some signs of helping to thaw the market for commercial paper. Some analysts said traditional short-term lenders including money-market funds, pensions and wealthy investors appeared to be getting more comfortable lending to the most creditworthy corporations.

"For at least investment-grade industrials, the bottom line is that things have gotten cheap enough that there are beginning to be buyers," said T.J. Marta, fixed-income strategist at RBC Capital Markets. "Our corporate traders said the market has been loosening up over the past week."

The major users of commercial paper are at the top of corporate America's food chain. Firms from conglomerates like GE and United Technologies to consumer goods firms such as Procter & Gamble and financial services companies like Citigroup use commercial paper because it is much cheaper than borrowing from banks.

A spokesman for United Technologies said it had no plans to use the Federal Reserve facility; Citigroup declined to comment.

Even if the flow of commercial paper is easing, it still has a ways to go.

As of Wednesday, the amount of commercial paper stood at $1.45 trillion, down from $1.82 trillion six weeks ago. That's well below the $2.2 trillion when the market peaked in the summer of 2007.

"The biggest, most successful companies are the most creditworthy, and even they are having difficulty tapping liquidity in the 'safe market,' " said Craig Peckham, an equity trading strategist at Jefferies & Co. "This is another manifestation of the broader migration away from risk. It certainly hit the commercial paper market and has translated into broadly higher rates for borrowers and less funds available."

Commercial paper is like an ultra-short-term bond, paying interest rates that are significantly lower than what banks would charge. The rate usually depends, at least in part, on the financial health of the company selling the paper. Companies often renew, or "roll over" the notes when they approach maturity, which typically runs from as little as seven days to as many as 90.

Following the collapse of Lehman Brothers, the rates for commercial paper went from 2.6 percent to over 4.5 percent, according to analysts. Coupled with general instability in the markets, would-be investors in commercial paper began to pull back.

The rates have since dropped but remain relatively high compared with their historic norms, according to investors.

The Federal Reserve said yesterday that it would charge 1.88 percent to buy unsecured commercial paper plus a 1 percent surcharge, and a rate of 3.88 percent for asset-backed commercial paper.

"There's been a lot of talk, but it remains to be seen how much activity there will be" at the Federal Reserve facility, Peckham said.

As Marta of RBC Capital Markets said, the Federal Reserve rate is "no free lunch."