Former U.S. Secretary of the Treasury Timothy F. Geithner and Professor Andrew Metrick survey the causes, events, policy responses, and aftermath of the recent global financial crisis.
Lecture: Asset-Backed Commercial Paper
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From the course by Yale University
The Global Financial Crisis
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Meet the Instructors
Andrew MetrickMichael H. Jordan Professor of Finance and Management
Yale School of Management
Timothy GeithnerLecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury
Yale School of Management
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What we saw in the previous lesson,
was a summary of what went on overall in the financial system.
BNP Paribas's announcement created enormous amount of anxiety.
That anxiety led to pressure.
On the inter-bank markets that lasted for the 13 months,
between BNP Pariba and the fall of Lehman.
And then, after the bankruptcy of Lehman Brothers in September of 2008,
there was an all out run on the banking system.
Now, that's the picture but the overall story seems to be missing several steps.
How is it that the pressure on the inter-bank system,
can lead to a failure of such a large organization as Lehman?
There are a few steps between the middle of August of 2007 and September of 2008,
that require us to go a little more deeply into the types of
financial activity that had gone on during the global savings glut.
The type of growth in the shadow banking system,
the growth in the creation of safe assets, and how those safe assets slowly
began to collapse, until they very quickly collapsed in September 2008.
Our first case study for this,
is a market called ABCP, or Asset Backed Commercial Paper.
And we'll begin with an introduction to what Asset Backed Commercial Paper is,
and then, see how the collapse of the asset-backed commercial paper market
contributed to the movement from anxiety to all-out panic.
Asset-backed commercial paper is primarily a method of maturity transformation.
That is, a way to fund a pool of long-term assets with short-term liabilities.
If you recall from an earlier module, we talked at length about how
Europeans institutions engaged in enormous amount of maturity transformation.
They had demands from their own investors.
That they would satisfy to give short-term liquid assets.
And those short-term liquid assets
would effectively be funded by long-term things on the balance sheet.
This type of maturity transformation is, basically, what banks do, and
what banks have done historically.
So, a bank that holds on its balance sheet, mortgage debt
that won't mature fully for 30 years, and that's what it has as assets.
And issues as liabilities demand deposits that can be taken out any day,
is engaging in maturity transformation.
It has long maturity assets and short maturity liability.
Asset backed commercial paper does the same thing, but off the balance sheet.
So, it will hold assets that might have fairly long maturities, and
it will issue liabilities that are much shorter.
Asset backed commercial paper is designed to meet specific needs of investors.
Often, these investors are money market mutual funds.
And it will include various enhancements for credit and
liquidity, so it can meet those specific goals.
For example, a money market mutual fund,
which prior to on the eve of the crisis in September of 2008,
money market mutual funds had $4 trillion of assets in the United States.
This is individuals, institutions, other large pools of cash that have given
their money to a specific type of mutual fund that is under very strict rules for
the types of investments that it's allowed to make.
It's only allowed to make investments that are short term.
So, what happens is the money market mutual fund
needs to have a lot of short term investments.
And if there aren't enough short-term investments in the world,
then a financial intermediary grows up, buys a lot of long-term investments, and
then issues short-term paper that can be held by the money market mutual funds.
So, a form of creation.
It is the manufacturing of a short-term asset.
Here's a picture, of which not every one of the boxes is crucial to understand.
The big circle in the middle is the Asset-Backed Commercial Paper Conduit.
So, this is a legal entity.
This legal entity is going to be buying and
selling assets that is coming from the sellers on the top.
And is going to issuing short term debt,
which is the oval, the ABCP investors on the bottom.
So, there's simply the creation of an intermediary, the intermediary will hold,
for example, Triple A rated, subprime bonds.
It will hold those.
It is entitled to buy them and sell them.
And what it will issue in return is, for example, 90 day paper, 90 day debt.
So, the bonds themselves don't mature for perhaps years.
But the debt needs to be rolled over every 90 days.
To ensure, that the conduit itself is safe, they will take
the rectangle over on the left, which is a credit enhancement provider.
So, somebody will guarantee the credit of the ABCP.
So, someone else is standing behind them.
And over on the right, a liquidity provider, often a bank,
that is giving them a backup line of credit, so
that if the investors refuse to roll over their short term debt,
the back will provide that, and enable them to pay back the old investors.
It looks similar in some ways conceptually to securitization.
Which we studied in an earlier module.
There are some important differences.
The first difference is that investments done by an ABCP
vehicle can be revolving and fluctuate in size.
Recall that a securitized vehicle is going to say exactly what they are buying
right at the beginning, and then there is no agency, there are no decisions
that are made by the securitized vehicle.
ABCP is different, it can buy and sell.
The conduits, the ABCP vehicles themselves,
may invest in various asset types.
Typically, in securitization, you will be just in mortgage debt or
just in student loans or just in auto loans.
An ABCP vehicle can be in a variety of things.
They typically engaged as we've discussed in maturity transformation.
That is they will have a long term assets and they will have short term liabilities.
In contrast, securitized bonds are designed so that overall, they pay
out at the same rate that they are being paid themselves from the underlying bonds.
So, there's a pooling aspect, and there is the elimination of agency risk aspect
in securitizations, but there is typically not maturity transformation.
Finally, there's no schedule to amortization of assets and liabilities.
A pool of securitized bonds is designed so that,
over time, it pays itself out completely.
An ABC PV vehicle can last in perpetuity.
There is no reason that it can't continue rolling over its debt forever.
Individual investors are not in forever.
They're only in for us long as they've loaned money to the vehicle.
But the vehicle, itself,
is not designed to end at any specific time.
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