If nothing else, the credit crunch has been a tour de force in the vernacular of the murky world of the credit markets.

We have gone from sub-prime to leveraged loans to carry trades — and this week’s latest is commercial paper or, more specifically, asset-backed commercial paper.

In essence, the commercial paper market is used by companies in need of short-term loans. They issue commercial paper, which is like a bond, as an IOU. Banks are big users of commercial paper. The banks package up billions of dollars of loans made to consumers or companies, through products such as mortgages and credit cards, into special financing vehicles called “conduits”. The banks then sell on the loans held within the conduits to investors, such as money market funds, insurance companies or other banks. They do this by issuing the commercial paper. The life of the commercial paper is typically very short, about 55 days. When the time is up, the bank managing the conduit will go back to the investors and roll over the commercial paper into another short-term agreement with similar interest rates.

In the United States, there is about $2.2 trillion (£1,100 billion) of commercial paper. About half of this is unsecured, like a personal loan taken out by a consumer, but $1.2 trillion of it is so-called asset-backed. This means that the loans are secured against assets such as the bank’s book of mortgage business.

The commercial paper market in Europe is worth $840 billion, of which about $300 billion is asset-backed commercial paper.

For the most part, the commercial paper market carries out its day-to-day business and rarely hits the headlines. In the past few weeks,

however, interest rates in the market have hit six-year highs as panicky investors have refused to roll over the paper. Instead of reinvesting in commercial paper that is coming to the end of its 55 days, investors are turning to other short-term safe havens, such as US government debt.

The pain has been particularly acute in so-called “single-seller conduits”, which are conduits linked only to one particular type of debt, for example mortgage loans. If that debt is exposed to American mortgages, the conduit, and the bank behind it, has problems.

For example, Countrywide Financial, the biggest US mortgage lender, was forced to draw down $11.5 billion of credit lines because of trouble with commercial paper. Financial institutions scrambled to end a crisis in

Canadian commercial paper and two small German banks were bailed out because of conduits with links to US mortgages.

The problems moved to Britain yesterday as HBOS was forced to provide facilities to its Grampian conduit to repay maturing commercial paper. In effect, the investors in Grampian would roll over and agree to reinvest in the paper only if HBOS was prepared to pay a higher interest rate on it. HBOS was not prepared to pay the higher cost and decided to take all the paper, worth about $37 billion, on to its own balance sheet and fund it itself, at cheaper rates. The bank plans to wait until the market has calmed down before trying to go back to the market and resell it to investors.

The big question now is which of the other big American and European banks could be hit next? HBOS was first to hold up its hand, but what of the other big lenders, such as Lloyds TSB and Barclays?

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