Fixing the money markets is more important than bailing out the banks
The US Federal Reserve is stepping beyond efforts to bolster and support short-term financial markets: it is replacing them.
Its special purpose vehicle to buy three-month commercial paper direct from top-quality issuers may well be used extensively by banks, but it also makes the Fed a direct lender to industrial corporations. That raises the question: if the banks are failing in their function to provide short-term cash loans to the broader economy, then what is the point of them? The logic of the vehicular finance system – whereby banks originated garbage assets and then created spurious structured vehicles to sell them to – is that banks become detached from the real economy. If, as a result, GE now struggles to raise short-term cash to pay suppliers or meet payroll, the Fed should lend directly to the company in recognition that it is a good credit and of value to society...unlike the broken banks.
For now, it is banks that are most at risk from high pricing or non-availability of short-term credit from the commercial paper market. And the price at which the Fed will provide funds to the new SPV, collateralized against the commercial paper it buys, suggests that it will be more attractive to banks. However US Treasury secretary Hank Paulson was quick to spell out that: “I expect this initiative to significantly improve the availability of funding for financial institutions and corporations that depend on the commercial paper market.”