Bailout signed, now it's wait and see its effects

The Federal Reserve announced a new program to help the battered market for short-term business loans - taking its closest step yet to lending directly to businesses. The program addresses commercial paper, a form of short-term funding that is crucial to many businesses operations. "The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility," the Fed stated.

Commercial paper is sold by major corporations and most of the nation's leading financial institutions. They use the proceeds to fund day-to-day business operations. It is bought primarily by money market fund managers and other institutional investors. "It's basically the checking accounting for business," said Kevin Giddis, head of fixed-income sales trading and research for investment firm Morgan Keegan. "It is literally how they operate on a day-to-day cash basis. It's their main funding source." Before the current credit crisis, there was nearly $2 trillion of commercial paper outstanding and was mostly issued for short terms - never more than nine months - and thus had to be renewed frequently.

For investors, it was considered a very safe investment to purchase and one that could be easily resold. But since the bankruptcy of Lehman on Sept. 15, many leading buyers of commercial paper have been afraid to play in the market, shifting their investments to safer U.S. Treasurys instead. No one wanted to get caught holding commercial paper for a company or financial institution that suddenly found itself in trouble. And the seize-up of the market itself was scaring investors. Even companies not facing financial problems are at risk of default on their commercial paper if they are not able secure another round of funding when their current borrowing matures.

Borrowing by consumers fell in August for the first time in more than 10 years as a weak economy continued to strain household budgets, according to a government report issued Tuesday. The Federal Reserve reported that consumer borrowing decreased by $7.9 billion in August to $2.577 trillion from a revised $2.585 trillion in July. The annual rate of consumer borrowing fell 3.7% last month. Credit card borrowing decreased at an annual rate of 0.8% while non-revolving borrowing, including student and auto loans, contracted by 5.4%.

Economists had expected borrowing to have increased by $5 billion in August, according to a poll conducted by Briefing.com. Tuesday's report marks the first time consumer credit has shrunk since January 1998, when it dropped $4.7 billion, or at a 4.3% annual rate. "This month's decline was predominantly due to a decrease in non-revolving lines of credit," said Sean Maher, associate economist for Moody's Economy.com.

Maher added that auto loans make up the bulk of non-revolving lines of credit and that the decrease in August reflects weak vehicle sales in the month of July. "Gas prices were high in July and consumers' transportation budgets were squeezed, which translated to a weak appetite for new vehicles," he said. While the 0.8% decline in credit card borrowing was less dramatic, Maher said that revolving credit has steadily increased on a historical basis and that the dip in August was "fairly significant."