The Fed released today that they will begin buying commercial paper in the money market. They are purportedly doing this to help ease liquidity constraints so that companies that rely on being able to finance operations through the commercial paper market will be able to do so. This is a significant shift of risk to the Fed from the companies producing commercial paper as well as the Treasury that began "insuring" the commercial paper market in September.

The commercial paper market is made up of institutional investors that buy very short term obligations from mostly finance companies. Other companies do participate in the market but the vast majority are financial firms. The paper is sold to provide cheaper financing than a line of credit from a bank. Trillions of dollars of debt is traded in this market making it one of the largest of the capital markets. Traditionally, this market was very low risk and offered low yields. 

The landscape of the "money market" or commercial paper market changed significantly in September when there were several runs on the banks involved including the bankruptcy of Lehman Brothers. At that point the Treasury stepped in and started insuring this debt through a fund that was established at the start of the great depression. In order to continue providing liquidity to this market and to keep rates as low as they are more risk has to be "removed" from the market so that lenders will be willing to take more market exposure. The plan is unlikely to work in the long term.

The implications of this move is that the Fed is essentially lifting some of the risk that the Treasury accepted in September so the Treasury/Fed team can continue to take on more risk from the private participants in the market. The problem with this is that it is merely shifting risk not eliminating it. This creates an unrealized loss problem that will eventually resurface elsewhere in the market like a diabolical "Whack-a-mole" game. Ultimately this is an important signal that market risk is not declining. That is very bad for equities and while it may be good for the USD short term it could whipsaw in the longer term. In the video, I will walk through this issue and why we are tracking the flow of risk to forecast our long term bias.

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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved."