What is a Money Market?

November 12th, 2008 | by admin |

If you have been following the global economy and its downturn over the last few months, then you have probably heard people talk about a problem with the money market and how this problem is impacting the economy at large. What is a money market and why is it so important?

On its most basic level, the money market is where banks and individuals go in order to lend and borrow over the short-term. While there are larger markets dedicated to the long-term lending and borrowing of things like equity, the money market is dedicated to bailing out financial institutions in their times of short-term need.

When a large bank or other financial institution needs short term liquidity, they head to the money market. Most financial trading happens with an eye on the long-term health of an investment, but these loans are not more than 13 months in most cases. Who are the players in this all important money market? As you might expect, the banks play a huge role in the investment proceedings.

They trade with each other, giving each bank the liquidity that it needs in order to cover its obligations. They aren’t the only ones playing in this high stakes, short-term game, though. Local, state, and even the federal government gets involved in the money market, as they need to issue “paper” in order to met the funding requirements of their given budgets. Paper can come in many forms, such as deposit notes, treasury bonds, federal funds, and municipal notes.

The entire idea behind the money market runs on what is known as paper. For the purposes of the economy, paper is the term given to these short-term investments made by banks and other entities. Even some businesses get into the business of needing paper, as they provide the basis for their own funding by issuing paper. In those cases, the paper is backed by reputable assets within the company and its investors.

The ability to get this paper is something that all banks and financial companies depend upon. In the last few months, we have seen a tightening of the money market more than anything else, and this has been the primary impetus for the economy’s slowdown.

The reason this tightening of the money market has had such a devastating impact is that banks are not able to meet their own obligations. Interest rates on these bank-to-bank loans have gone up and fewer banks have the ability to help each other out in this way. With no paper at their disposal, financial institutions don’t have the ability to offer loans to customers that would typically qualify.

When there is less money available for the banks to do their business, the trickledown effect means that there will be less money for customers. This has had an impact on not only personal loans, but also on commercial loans. The liquidity just is not there for customers who would have liked to have expanded their business or even started a small business.

When financial pundits talk about the Federal Reserve board cutting interest rates, they are primarily referring to the interest rate that banks use in their dealings with each other. This pertains directly to the money market, where banks have to get their hands on paper. The financial crisis will not get any better until something is done to add a measure of liquidity to the mix for these financial institutions. With their ability to interact in the global money market being restricted by the overall credit squeeze, things are difficult on both ends of the spectrum.

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