Academic journal article Federal Reserve Bank of St. Louis Review

The Commercial Paper Market, the Fed, and the 2007-2009 Financial Crisis

Academic journal article Federal Reserve Bank of St. Louis Review

The Commercial Paper Market, the Fed, and the 2007-2009 Financial Crisis

Article excerpt

Since its inception in the early nineteenth century, the U.S. commercial paper market has grown to become a key source of short-term funding for major businesses, with issuance averaging over $100 billion per day. In the fall of 2008, the commercial paper market achieved national prominence when increasing market stress caused some to fear that, given its size and importance, the market's failure would sharply worsen the recession. The Department of the Treasury and Federal Reserve enacted programs targeted at providing credit and liquidity to restore investor confidence. The authors review the history of the commercial paper market, describe its structure and key relationships to money market mutual funds, and present a detailed discussion of the crisis in the market, including the resulting Federal Reserve programs. (JEL G01, G24, E52)


For both small and large American businesses, commercial paper (CP) issuance is an important--and often lower-cost--alternative to bank loans as a means of short-term financing. Paper is sold in different forms: Some paper is sold unsecured (that is, without specific collateral), while other paper is secured by bank-issued letters of credit or pools of assets, including a firm's receivables. The funds raised through CP issuance have a variety of uses, including payroll and inventory finance.

CP is important for investors as well. Larger investors, including institutions, directly purchase CP as a short-term, low-risk investment. For smaller investors, money market mutual funds (MMMFs) intermediate between larger-denomination CP and the liquid, smaller-denomination shares that they issue to the public. (1)

Since the inception of the CP market in the early nineteenth century, it has grown such that today CP issuance exceeds that of Treasury bills. The early years of the CP market were dominated by issuers in the nonfinancial sectors of the economy, including transportation and utility companies, who borrowed by issuing CP to wealthy individuals, other businesses, and financial institutions. By the twentieth century, as the demand for durable goods rose and consumers began purchasing items on credit, the CP market became dominated by financial issuers. The rise of MMMFs during the 1970s boosted the growth of CP by (indirectly) allowing small investors access to CP investments. During the 1980s, the CP market began to develop into its current form, particularly with the creation of the asset-backed commercial paper (ABCP) conduit.

During the autumn of 2008, some feared that stress on--and potential failure of--the CP market might sharply worsen the recession. In response, the Treasury and Federal Reserve enacted programs to restore stability. These programs focused on enhancing market liquidity, not on removing default risk from the market.


In its traditional form, CP is an unsecured promissory note issued by a business (either financial or nonfinancial) for a specific dollar amount and with maturity on a specific date. (2) Companies issue CP as a low-cost alternative to bank loans, as it is exempt from Securities and Exchange Commission (SEC) registration. (3) CP is generally issued in large denominations of ($100,000 or more). The maturity on CP averages 30 days but may range up to 270 days. Proceeds from CP issuance are used to finance "current transactions," including meeting payroll obligations, and funding current assets, such as managing receivables or inventories. Figure 1 displays the maturity composition of CP issued in 2008; that year, the majority of CP had a maturity of less than 1 week.

Similar to Treasury bills, CP is typically issued at a discount, meaning that the buyer pays less than face value and receives face value at maturity: The "interest" is equal to the face value minus the purchase price. Although CP is issued at short maturities to minimize interest expense, many issuers roll over CP by selling new paper to pay off maturing paper. …

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