North Jersey companies encouraged by Fed's decision to buy short-term debt

Oct 08, 2008 (The Record - McClatchy-Tribune Information Services via COMTEX) -- PEG | Quote | Chart | News | PowerRating -- North Jersey companies that rely on the commercial paper market cheered the Federal Reserve's move Tuesday to breathe life into the little-watched -- through crucial -- aspect of the credit crisis.

Like many companies, Public Service Enterprise Group, the Newark-based parent of New Jersey's largest utility, needs commercial paper, a form of short-term debt, to pay its employees, taxes and other expenses while it waits for its customers to pay their bills.

"It gets us through all the peaks and valleys in the month," said Mort Plawner, the company's treasurer.

The recent investor exodus, however, has left the commercial paper market "basically frozen," making it "virtually impossible" to borrow a few hundred million dollars with that form of short-term debt, he said.

While many watch the daily rises and falls of the stock markets to gauge the economy's health, the equity that financing companies secure by issuing stock is reserved for long-term projects like building plants or expanding.

Commercial paper, on the other hand, is what companies need to keep running day to day, week to week. Companies typically borrow the money for 30 or 90 days.

This market is not glamorous. Companies issue what are basically IOUs -- sometimes secured, other times not -- directly to money markets or to dealers or banks, and use the money to pay suppliers and employees.

Across the U.S., about 1,700 companies rely on commercial paper, said Sorin Tuluca, a professor of finance at the Silberman College of Business at Fairleigh Dickinson University in Madison.

Without commercial paper, Tuluca said, "You cannot do anything. You don't pay your employees. You don't produce the products, so you don't turn products into cash.

"If you don't have a commercial paper market or another source, like a bank loan, basically you are doomed to failure," he added.

Last week, the commercial paper market reached a three-year low with about $1.6 trillion in outstanding debt.

"As a result," the Fed said in a statement Tuesday, "the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day."

Mark Gertler, a professor of economics at New York University, said a worsened commercial paper market could lead companies to lay off employees.

"The fear is that a lot of them will have to cut back on their expenditures," Gertler said.

To prevent further chilling of the market, the Fed announced its plan to create a special fund to purchase commercial paper, essentially putting itself into the business of lending money to businesses -- an unusual move for an institution that has historically lent only to banks.

PSEG's Plawner praised the Fed's move.

"From what I gather, they are going to be buying paper from the biggest issuers," he said of the Fed. "They won't be directly buying our paper, but [the Fed's actions will] free liquidity for second tier issuers like us. The indirect effect will be helpful to us as well."

Paul Dickard, a spokesman for Ingersoll-Rand Co. Ltd., whose operations are based in Montvale, was also optimistic.

"Commercial paper is an ongoing way we manage our capital needs," he said. "It's good to have another participant in the process. The Fed's entree into the market provides more liquidity, which is good."

In August, the company issued $950 million in commercial paper.

"We're investment grade, so there are people out there willing to take our paper," he said. "It's not a situation where we're running into a major crunch. [The Fed] is another participant in the marketplace, a participant with a lot of face and credit. It's good for the system."

FDU's Tuluca thinks the Fed's foray into the commercial paper market will not only keep companies afloat but also boost confidence, which could restore stability in the markets.

"It is a serious situation," he said, but the Fed's new program could help the situation "improve dramatically."

Gertler said the Fed's program makes sense. "There's a direct effect -- they'll be having money flow into the market -- and then also they will help calm the markets to stall the run."

The commercial paper market's problem is among the most pressing facing the U.S. economy, Gertler said.

"It ranks high because right now, we're looking at a modest downturn," he said. "But if the credit markets freeze, it could be a much more serious downturn."

By Andrew Tangel and Kevin G. DeMarrais.

To see more of The Record, or to subscribe to the newspaper, go to http://www.NorthJersey.com. Copyright (c) 2008, The Record, Hackensack, N.J. Distributed by McClatchy-Tribune Information Services. For reprints, email tmsreprints@permissionsgroup.com, call 800-374-7985 or 847-635-6550, send a fax to 847-635-6968, or write to The Permissions Group Inc., 1247 Milwaukee Ave., Suite 303, Glenview, IL 60025, USA.

More News:   Market Updates | Stock Alerts | All Trading News | Stock Index