Commercial paper outstanding declined in October for the third month in a row, providing further evidence of slack demand for credit and jitters about short-term credit quality.
The amount outstanding slipped by $3.61 billion, to $528.28 billion, according to the Federal Reserve Bank of New York.
Nearly two-thirds of the October decline occurred among banks and other finance companies in the grip of an economic downturn.
But the percentage decline in nonfinancial company paper was greater, at 1% compared to the financial companies' 0.6%.
"We are in a pretty nasty recession. Corporations are not jumping up and down to borrow money," said Jean Louis Lelogeais, a vice president in the capital markets group of Booz Allen & Hamilton Inc., a management consulting firm.
Although commercial paper is strictly a short-term security, heightened concern about credit quality has nevertheless eroded the market.
The Securities and Exchange Commission gave this momentum a shove last year when it took steps to bar mutual funds and pension funds from owning large amounts of commercial paper that is not top tier.
The resulting rule accelerated investors' flight to quality, which was under way already.
The focus on high-quality commercial paper issuers has hurt big banks in the past two years.
As credit ratings faltered, driving up the cost of long-term debt, Chase Manhattan Corp., Citicorp, and other money-centers began to rely more heavily on commercial paper to satisfy their funding needs.
But investors are no longer able to overlook short-term credit quality.
"Commercial paper now requires high ratings," said David Cates, of Ferguson & Co.
Fed Funds Borrowing
Meanwhile, banks are lining up fed funds to carry them into 1992, but at half the pace of a year ago.
In the past, banks moved early to guarantee access to enough short-term funds to close out a year with sufficient liquidity.
And the rates on those contracts, which have been as high as 14%, are well below the 22% banks were willing to pay in 1990.
The relative quiet suggests that a number of banks are less willing to trade with other banks.
Sales at high rates can be profitable, but they reduce a bank's liquidity and they can inflate its balance sheet, thereby reducing capital-to-assets ratios.
"A lot of banks are going to be keeping a very low profile," said one money market trader. "Some banks are going to have to stretch their capital as far as they can."
Foreign banks have been big buyers of contracts for yearend fed funds in past years.
In fact, they have been such eager bidders they have had to pay premium rates to get all the funds they wanted.
Selling to Foreign Banks
Some U.S. banks have even taken advantage of the high rates foreigners were willing to pay, purchasing fed funds at their own low rate and turning around to sell the funds to foreign banks at a higher rate.
But this year is different. Foreign banks have shrunk their balance sheets to improve their capital ratios and have reduced their funding needs as a result.
"The Japanese have much smaller balance sheets," said one fed funds trader. "They're not flinging around the money they used to."
Ratios Are Uppermost
And many U.S. banks are holding back from selling funds to their foreign counterparts.
Faced with their own capital constraints, they are reluctant to make what amount to new loans that would enlarge their balance sheets and reduce their capital ratios -- even if it means forgoing profits.
"This year, there really is no pressure for yearend funding," said a fed funds trader at a regional bank. "Banks really have no reason to build up their balance sheets."
As expected, the Federal Reserve pumped more than $2 billion into the banking system Tuesday, aimed at reducing the fed funds rate.
The target funds rate is 4%, set last week when the Fed lowered the discount rate.
But banks have been charging each other 4.625% for the overnight loans.
Fed funds traders said banks have been borrowing money to settle their Fed accounts, driving up rates.
In addition, some banks are adding cash to their balance sheet for the end of the quarter.
After the Fed stepped in, the rate dropped slightly to 4.5%. Traders don't expect the rate to drop to 4% until after Jan. 1.