FEDERAL Reserve chairman Ben Bernanke may find the next fronts of the financial crisis to be just as chilling as last month's downfall of Wall Street titans: its spread to corporate America and state and local governments.
Companies from Goodyear and Duke Energy to Gannett Co and Caterpillar are being forced to tap emergency credit lines or pay more to borrow as investors flee even companies with few links to the subprime-mortgage debacle. California Governor Arnold Schwarzenegger says his and other states may need emergency federal loans as funding dries up.
A cash crunch on Main Street would endanger the basic functions of companies — paying suppliers, making payrolls and rolling over debt. The widening of the crisis suggests Bernanke and Treasury Secretary Henry Paulson may have further fires to put out even as the Treasury sets up the $US700 billion ($A905 billion) financial industry rescue plan approved last week.
The market for commercial paper, which typically matures in 270 days or earlier and is used to pay expenses such as payroll and rent, shrank to a three-year low of $US1.6 trillion in the week to October 1.
Gannett, the largest US newspaper publisher, said last week it had drawn on a revolving credit line to ensure it had funds to repay its commercial paper. Utility owner Duke Energy last week tapped $US1 billion from a $US3.2 billion credit agreement after concluding it might not be able to meet its plan for new financing. Caterpillar, maker of earthmoving equipment, had to pay the biggest premiums over treasuries in at least three decades at a sale of five-year and 10-year notes.
"Credit is the lubricant that oils the engine of the economy" and if it dries up "the engine seizes up", said Republican Representative Michael Conaway of Texas, who switched his vote last week to support the financial rescue. The inability of a major corporation to renew its short-term loans would have "a devastating impact on the economy".
Even as confidence grew that Congress would approve the bail-out, banks hoarded cash, suggesting the proposed purchases of devalued mortgage assets might not stop the credit crunch from widening.
Corporate bond sales shrank to $US1.25 billion last week, capping the worst four-week slump since 1999.
Lending between banks is also seizing up. The gap between the three-month London interbank offered rate and the overnight indexed swap rate, a gauge of cash scarcity among banks, climbed to a record 2.80 percentage points three days ago.
Republican Representative Jerry Moran of Kansas encouraged the Fed to consider guaranteeing loans between banks.
"We will continue to use all the powers at our disposal to mitigate credit-market disruptions," Bernanke said on Friday. He is to deliver a speech on the economy today.
The central bank has power to extend credit to any company under "unusual and exigent circumstances". It used that authority earlier this year to avert the failure of Bear Stearns, take over American International Group and lend to banks to shore up money-market funds. The Treasury last month set up a program selling debt to help the Fed expand its balance sheet.
Investors anticipate the Fed will cut rates in an attempt to lower borrowing costs and encourage banks to lend. Futures prices show 100% odds of a half-percentage-point reduction in the 2% benchmark rate at or before the October 28-29 policy meeting.
State and local governments having trouble meeting cash needs may push for help. Schwarzenegger told Paulson last week that California and other states "may be forced to turn to the federal Treasury for short-term financing" if the crisis didn't ease.
"If states can't access the credit markets because of market conditions, then the Treasury should consider providing it," said Ben Watkins, a member of the debt committee of the Government Finance Officers Association, a group of public finance officials.
Without funding, states "can't operate the health-care system, schools, roads and other services they provide", said Watkins, who also serves as head of Florida's bond sales.
Market disruptions forced Oregon to cancel a $US21 million sale of bonds for the state university system and several other planned issues were in jeopardy, State Treasurer Randall Edwards said. "There's really no market, there are no buyers out there," he said.
State and local government funding "has to be a concern for Bernanke and Paulson", said Adam Posen, deputy director
of the Peterson Institute for International Economics in Washington. "There are two issues now: stop the immediate panic; and restructure the financial system."
Those aren't the only areas Fed and Treasury officials may be concerned about.
Since 2005, New York Fed President Timothy Geithner has been pushing to reduce risks in the $US54.6 trillion credit-default swaps market. Concerns rose after the Fed had to rescue AIG with an $US85 billion loan to cover obligations at a unit that sold protection against debt default.
BLOOMBERG
