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.
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.
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.
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.
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.
$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.