Trying to make sense of the crisis on Wall Street is not easy, as most investors know by now. Helping us navigate through the gnarly forest of largely-unknown terms and tools today is
Manish Jain, the Fized Income Portfolio Manager for Zacks Investment Management.
What exactly happened when "the markets froze" that caused the fear of a market meltdown and the need for a $700 billion bailout by the Fed?
Basically what?s going on is a crisis of confidence. It?s a lack of confidence at the person sitting across from you when you are lending him money. What AIG (AIG), Lehman, Bear Stearns and Merrill Lynch (MER) have taught us is that how quickly a company can be collapsed.
With this fear in their mind, banks have been reluctant to lend money and have been hoarding cash in case they themselves need it for their own survival. Rates on any unsecured lending have again shot up dramatically over the past week. Lenders were basically saying that if you want to borrow some money from us without putting up any collateral, we are going to charge you much more today than yesterday.
What about Commercial Paper? Did this trading stop for some time period?
The Commercial Paper market involves companies borrowing money either overnight or for some really short term (7 days or 30 day). In some cases they can go up to one year. The borrowings are mostly unsecured. A lot of companies borrow money in this market for their day-to-day operations. The types of companies borrowing span the entire globe, but mostly its financial companies.
The Commercial Paper market has not stopped but has shrunken quite a bit over the past couple of months. As lenders demand higher and higher rates, borrowing companies are either forced to pay up the higher rate or issuer longer term debt so they don?t have to go back to the market on a daily basis. In either case, the borrower is forced to pay a lot higher rate than what they were paying before.
For example, a company could have been paying around 3% to borrow overnight money. Now the same company is probably looking to pay around 4% to 5% for the same amount of time. If the company decides to borrow for a longer term, then the rates start climbing up and now they are looking at in the 5% to 6% area.
Can you tell us a little about LIBOR?
LIBOR means London Inter Bank Offering Rate. It is calculated and issued by the British Bankers Association (BBA). It is the rate that the banks lend to each other for various maturities.
