Fed's Bernanke Bets Big On New 'Confidence' Game

If you thought the federal government’s $700 billion economic recovery plan was a huge gamble, then hang on. You ain’t seen nothing yet.

In a dramatic move aimed at breaking the credit crunch, the Federal Reserve is essentially agreeing to lend short-term money to major corporations — a move that could also run hundreds of billions of dollars. While the Fed isn’t giving cash directly to credit-strapped corporations such as General Motors or GE, it is creating a special investment vehicle designed to  guarantee — or back stop – these companies’ short-term commercial borrowing needs.

Such funding is the lifeblood of most major companies; currently 1,700 businesses regularly use the commercial paper market. Short-term loans provides for payrolls, placing orders, buying equipment and other immediate needs. In calmer times, companies routinely access the commercial paper market and get financing from banks or money market funds. But during these turbulent days, those transactions are slowing to a crawl as buyers back off from buying commercial paper because they fear  borrowers won’t be able to repay their debts.

The numbers are worrisome: Short-term debt maturing in 270 days or less fell $90.2 billion to a seasonally adjusted $2.04 trillion in the week that ended yesterday, according to the Fed. Commercial paper outstanding has tumbled by $181.3 billion, or more than 8 percent, in just two weeks.

For Federal Reserve Chairman Ben Bernanke  it’s all about rebuilding confidence in the economy. Indeed, while the recently-passed federal bailout may prove effective in the long term, Bernanke can’t afford to allow the current credit crisis to continue. With lenders refusing to buy commercial paper, companies are forced to tap their credit lines — a costly, short-term step that doesn’t ease the corporate funding crunch.

Already, credit experts are welcoming the Fed’s unprecedented action. Many contend the government guarantee will raise the comfort level of commercial paper buyers. They’re expecting short-term financing will more easily flow.

While that would be welcome news to many major corporations, it does virtually nothing for mid-sized and small businesses, which do not tap the commercial paper market for funding. Typically, those concerns rely on traditional bank loans, or credit cards, for their short-term financing needs. Until more commercial banks start lending again, those companies will still be in harm’s way.

Right now, however, the Fed’s paramount concern is improving confidence and inspiring banks to start lending again to their prime customers and even other banks. Meanwhile, Bernanke is betting the bailout will  improve the banking industry’s balance sheet and free up capital for more business loans.

Until that occurs, however, the chairman is placing the Fed’s money — and stature — on saving Corporate America.