Recently by David Stockman: Our Failed National Economy
If Warren Buffett wants to tarnish his golden years emitting the gushing drivel that appears in today’s New York Times, he has undoubtedly earned the privilege. But even ex cathedra pronouncements by the Oracle of Omaha are not exempt from the test of factual accuracy. Specifically, his claim that “many of our largest industrial companies, dependent upon commercial paper financing that had disappeared, were weeks away from exhausting their cash resources” is unadulterated urban legend. Nothing remotely close to this ever happened.
The fact is, there was about $2 trillion in commercial paper outstanding on the eve of the Lehman failure. And it’s true that funding of this short-term paper was highly dependent upon money market funds that suffered multi-hundred billion outflows after First Reserve broke the buck owing to its holdings of toxic Lehman paper. So it’s accurate to say that the commercial paper market had seized up and that massive amounts of maturing paper had no ability to roll.
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But those specific facts about the condition of the CP market do not remotely prove that the nation’s great industrial corporations were on the edge of an economic black hole or that Main Street would have experienced crippling waves of defaulted payrolls for lack of cash. Indeed, even a cursory review of the composition of the $2 trillion CP market as of September 2008 shows that the “blowup” was actually about losses on reckless bets by a few thousand money managers, not the availability of ready cash to millions of Main Street businesses.
In the first instance, well less than $400 billion of the total CP outstanding consisted of industrial corporation paper – that is, funding of the kind that might have been ordinarily used to cover payrolls and similar operating expenses. But let some enterprising graduate student investigate the limited universe of investment grade industrial companies then accessing the CP market. How many of these issuers lacked unused back-up revolving credit lines at the banks – for which they had been paying “standby” fees year in and year out for just such a contingency as the Lehman event seizure in the CP market? The answer is virtually none: The great industrial companies to which Buffett refers used CP because it was cheaper (even with 15 bps of standby revolver fees), not because they wished to put their enterprise in harms way every 45 days. Moreover, there is not a shred of evidence that any bank even threatened to default on contractual obligation to fund these back-up lines.
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The next crucial fact is that the entire balance of commercial paper then outstanding – some $1.6 trillion – had nothing whatsoever to do with funding business payrolls or heat and light bills. Instead, it consisted entirely of the short-term liabilities of the shadow banking system – funding that permitted the financial arbitrage profits on which the whole system was based.
The largest single piece was about $1 trillion of asset-backed commercial paper (CP-ABS). Said assets consisted of auto loans, student loans, credit card loans, and the like, which retail financial institutions had originated, securitized, and sold into CP-ABS conduits that they sponsored. The whole point to this money shuffle was that, on average, the wholesale funding that could be accessed through the CP-ABS market was cheaper than the retail funding banks could obtain on their own balance sheets. The result was higher profit spreads on the auto paper originated by the banks, not funding for the payroll costs of the army of clerks who processed the loans.
Because the securitized ABS market has now shrunk to a shadow of its former self, it can be definitively said that nothing was flushed down an economic black hole in the fall of 2008 or at any time since. Not one auto loan has even been denied and not one credit card authorization request has even been disapproved because the CP-ABS market disappeared. Instead, such loans are now largely funded and retained on the balance sheets of the banking system originators – which, drowning in excess reserves anyway, haven’t broken a sweat. What has disappeared are the arbitrage profits that banks were raking off from foolish money fund managers who have finally seen that the “enhanced yield” they were obtaining from CP-ABS paper was not evidence of a better mousetrap – just their own cupidity.
The remaining $600 billion or so of CP outstanding was issued by non-bank Finance Companies like GE Capital, G-MAC, and CIT Group. Here’s where the urban legend gets positively malodorous. At the time of the crisis, these companies were knee-deep in the ancient scam of lending long and slow (i.e. illiquid) and borrowing short and hot. The resulting yield curve arbitrage generated fulsome accolades and bonuses for the portfolio managers and executives – until the mullet money in the CP market violently scampered off the deck.
November 18, 2010
