Business lending falls again

Credit squeeze continues as commercial paper, a key source of funding for major businesses and banks, drops again.

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By Chris Isidore, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- The market for commercial paper, a key form of lending to major businesses and banks, continued to shrink in the past week, according to a report from the Federal Reserve Thursday.

The latest figures released Thursday morning show total commercial paper outstanding fell by $56.4 billion, or 3.5%, in just the past week, to $1.55 trillion.

The decline marks the fourth straight week of declines, a fall that has reduced total commercial paper outstanding by $264.4 billion, or 15%, as the credit crisis escalated on Wall Street.

"What that tells you is that corporations that have generally been able to borrow in that market have been frozen out," said Lyle Gramley, a former Fed governor now serving as an economist with the Stanford Group.

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."

The sharp drop in commercial lending in recent weeks prompted the Fed to announce an unprecedented program to have the central bank start to buy the paper, a move that essentially will have the Fed lending money directly to many major companies.

Many details of the Fed's plans are still being worked out. Fed officials who briefed reporters on the program Tuesday said they hoped just the announcement of the Fed's plans to buy commercial paper would assure investors to return to that market knowing that the central bank would soon be a backstop.

Gramley said he's hopeful that the Fed's commercial paper program will start to solve the problem soon, but that it didn't have enough time to have any meaningful impact on this latest reading.

"I would say probably by next week's numbers, things will be beginning to settle down," he said.

For investors, commercial paper was considered a very safe investment to purchase, even if most of it was backed by little more than the company's and banks good reputation. The strength of the firms selling the paper meant it 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 financing to pay off their paper that had matured. To top of page

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