FED to Purchase Commercial Paper as an Offset to the Credit Crunch

Today’s 3-month LIBOR stands at 4.32% while yield on 3-month Treasury bills is less than 0.8%. While we thought Friday’s bail-out legislation would alleviate the credit crunch – the TED spread still exceeds 3.5%. Dean Baker says the FED has found a plan B:

It turns out that the Fed can buy commercial paper directly from non-financial corporations needing credit to maintain operations. This will keep the credit markets working even if the zombie banks aren't up to the task. In other words, the threat of a complete meltdown in the absence of a bailout was nonsense and the media once again got taken for a ride by the Bush administration.

The Federal Reserve reports interest rates both for 3-month nonfinancial commercial paper and for 3-month financial commercial paper. As of October 1 (latest date reported), the interest rate on the former (what Dean seems to be discussing) was only 2.27% while the interest rate on financial commercial paper was 3.81%.

The NY Times article that Dean relies on states:

The Fed plan is intended to renew the flow of credit on which the economy depends. Under its plan, the central bank would buy unsecured commercial paper, essentially short-term i.o.u.’s issued by banks, businesses and municipalities.

Given the spread between interest rates on financial commercial paper and nonfinancial commercial paper, it would be interesting to see which sector the FED’s plan B will focus on.