Friday, December 21, 2007

Discount Rate Spread Still Increasing

by Calculated Risk on 12/21/2007 11:26:00 AM

From the Fed weekly report on commercial paper this morning, here is the discount rate spread:

Discount Rate SpreadClick on graph for larger image.

According to the Fed, the discount rate spread is still increasing. This is the graph released this morning.

Meanwhile, the Fed is still pouring liquidity into the market with another $20 billion TAF auction yesterday. And the Fed has announced:

The Federal Reserve intends to conduct biweekly Term Auction Facility (TAF) auctions for as long as necessary to address elevated pressures in short-term funding markets. The Board of Governors will announce the sizes of the January 14 and January 28 TAF auctions at noon on January 4.
Here is the discount rate spread graph from last week:

Discount Rate Spread

Clearly this indicator of the credit crisis has worsened.

Here is a simple explanation of this chart: This is the spread between high and low quality 30 day nonfinancial commercial paper.

What is commercial paper (CP)? This is short term paper - less than 9 months, but usually much shorter duration like 30 days - that is issued by companies to finance short term needs. Many companies issue CP, and for most of these companies the risk of default is close to zero (think companies like GE or Coke). This is the high quality CP. Here is a good description.

Lower rated companies also issues CP and this is the A2/P2 rating. This doesn't include the Asset Backed CP - that is another category and is even at a higher rate (see commercial paper table).

The spread between the A2/P2 and AA paper shows the concern of default for the A2/P2 paper. Right now the spread is indicating that "fear" is very high. It is actually very rare for CP defaults, but they do happen (see table 5 in the above Fed link).