Commercial paper is still worth a lot of money
— -- Q: How does commercial paper work?
A: The commercial paper market is an important part of the capital markets that allows big, stable borrowers to borrow money quickly and inexpensively.
These companies have many avenues to borrow, but they use the commercial paper market because it is easy to tap and it's cheap. The market for commercial paper is gigantic: more than $2 trillion.
About half the commercial paper market is used by these esteemed and well-capitalized companies. Generally, they sell commercial paper that comes due in a few months, using the cash to build inventory in a product that's going to be sold. A car maker, for instance, might sell commercial paper so it can manufacture cars it will sell in a month or so. When the cars sell, the company pays off the commercial paper.
Another part of the commercial paper market is made of up so-called asset-backed securities. That is, the loans are backed by specific company assets. The assets can be of different quality, from receivables to subprime mortgage loans. And it's this corner of the asset-backed commercial paper market that's run into trouble.
Worried about rising mortgage defaults, investors have been unwilling to buy commercial paper backed by mortgages. This is been a major problem for mortgage lenders like Countrywide, which relied on the market to raise money to lend. When the commercial paper market isn't available to a company like Countrywide, it must turn to other, higher-cost sources of funds, such as bank loans or outside investors. Countrywide has done both.
What's the future of the commercial paper market? Most people I speak to say commercial paper sold by strong companies will continue to be healthy. And even asset-backed paper, backed by high-quality assets, will be fine. But the days of mortgage-backed commercial paper sales may be numbered. The commercial paper market is seen as a place only for elite issuers, and mortgage-backed commercial paper has demonstrated that it doesn't fit that definition in many cases.
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