The federal government’s field trip into the private sector looks to be taking another weird turn, as Fed officials openly discuss the possibility of purchasing short-term commercial paper to ensure companies don’t start cutting headcount. The Fed has all but stated that they would have to fire up the printing presses to afford any significant portion of the $1.6 trillion in paper that no one wants to touch right now.
This proposed action only deepens the potential legal fallout of the government’s actions over the last six months. To say that both the Fed and the Treasury have been, from a legal perspective, flying by the seat of their pants is a dramatic understatement. A quick stroll through the Fed’s charter revealed nothing that would provide even the framework for such a foray into the public markets. In the absence of any legal authority to buy and sell commercial debt offerings, the best solution they have come up with so far is to create an L.L.C. as a shell company. I mean, it isn’t such a bad plan. Bernanke can get all of the paperwork he needs for a mere $69.99 (shipping and handling not included).
On a serious note, this could get messy very quickly. Consider the following scenario:
1) Fed/Treasury creates private vehicle BadDebt , L.L.C. to implement this strategy
2) Cashco, a financial services firm, experiences cash flow shortages and is in trouble. BadDebt buys $10M in their short-term paper.
3) CashCo, Inc. survives their cash flow hiccup, and within a month is back in the market. Their investment arm buys $10M in commercial paper from Acme Corp, a regional manufacturer experiencing cash flow shortages.
4) Three months later, BadDebt., LLC also buys $10M in a future round of commercial paper issued by Acme.
5) Acme Corp craters, defaults on the paper and files for Chapter 11.
Now, the government finds itself as both judge and claimant in bankruptcy court. By law the Bankruptcy judge must treat BadDebt’s claims as subordinate to CashCo’s. The net outcome is that the government ends up financing and presiding over their own haircut.
One cannot fault the Fed or Treasury for placing these kinds of issues aside for later consideration, given the magnitude of the liquidity crises in which we’re immersed. That being said, I would suggest that Congressional oversight committees leave their calendars open next summer. They are going to have a lot of cleaning up to do.
This proposed action only deepens the potential legal fallout of the government’s actions over the last six months. To say that both the Fed and the Treasury have been, from a legal perspective, flying by the seat of their pants is a dramatic understatement. A quick stroll through the Fed’s charter revealed nothing that would provide even the framework for such a foray into the public markets. In the absence of any legal authority to buy and sell commercial debt offerings, the best solution they have come up with so far is to create an L.L.C. as a shell company. I mean, it isn’t such a bad plan. Bernanke can get all of the paperwork he needs for a mere $69.99 (shipping and handling not included).
On a serious note, this could get messy very quickly. Consider the following scenario:
1) Fed/Treasury creates private vehicle BadDebt , L.L.C. to implement this strategy
2) Cashco, a financial services firm, experiences cash flow shortages and is in trouble. BadDebt buys $10M in their short-term paper.
3) CashCo, Inc. survives their cash flow hiccup, and within a month is back in the market. Their investment arm buys $10M in commercial paper from Acme Corp, a regional manufacturer experiencing cash flow shortages.
4) Three months later, BadDebt., LLC also buys $10M in a future round of commercial paper issued by Acme.
5) Acme Corp craters, defaults on the paper and files for Chapter 11.
Now, the government finds itself as both judge and claimant in bankruptcy court. By law the Bankruptcy judge must treat BadDebt’s claims as subordinate to CashCo’s. The net outcome is that the government ends up financing and presiding over their own haircut.
One cannot fault the Fed or Treasury for placing these kinds of issues aside for later consideration, given the magnitude of the liquidity crises in which we’re immersed. That being said, I would suggest that Congressional oversight committees leave their calendars open next summer. They are going to have a lot of cleaning up to do.
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