Electronic copy available at: http://ssrn.com/abstract=1712442 The Financial Sector and the Real Economy during the Financial Crisis: Evidence from the Commercial Paper Market Ethan Cohen-Cole University of Maryland - College Park Judit Montoriol-Garriga Federal Reserve Bank of Boston Gustavo Suarez Federal Reserve Board Jason Wu Federal Reserve Board November 19, 2010 Abstract Shocks to the nancial sector led credit spreads to widen to unprecedented levels in many markets during the 2007-2008 nancial crisis. The rise in spreads attracted attention because it could signal a disruption in nancial markets, which has been widely linked to an increased burden on non-nancial rms. This paper disentangles the relative contributions of credit and liquidity risk in explaining the widening of commercial paper spreads. In doing so, we nd that liquidity risk was isolated to the nancial sector throughout the rst two major shocks to the system (August 2007 and March 2008). Indeed, controlling for credit risk, non-nancial corporations saw little or no change in the cost of funding during this time period. After the bankruptcy of Lehman Brothers, for the rst time, liquidity problems in the commercial paper market spilled out of the nancial sector into the spreads of low credit quality non- nancial rms. This e/ect had a disproportionately larger impact on those low credit-quality non-nancial rms that placed paper exclusively through nancial sector dealers. High credit quality rms remained una/ected throughout. Our interpretation of the results is that markets were able to di/erentiate not only between safe and imperiled rms in the midst of the crisis, but also to isolate where liquidity e/ects were most likely to be salient. Ethan Cohen-Cole: Robert H Smith School of Business. email: ecohencole@gmail.com. (301) 541-7227. Judit Montoriol-Garriga: 600 Atlantic Avenue, Boston MA. email: judit.montoriol-garriga@bos.frb.org. Gustavo Suarez Federal Reserve Board of Governors. email: gustavo.a.suarez@frb.gov. (202) 452-3011. Jason Wu Federal Reserve Board of Governors. email: jason.j.wu@frb.gov. (202) 452-2556. The views expressed in this paper are those of the authors and do not necessarily reect those of the Federal Reserve Bank of Boston or the Federal Reserve System. 1