The Evolution of a Financial Crisis: Panic in the Asset-Backed Commercial Paper Market Daniel Covitz, Nellie Liang, and Gustavo Suarez* Federal Reserve Board September 30, 2009 * The views expressed here do not reflect those of the Federal Reserve System or its Board of Governors.

2 The ABCP market in 2007: Outstandings

3 The ABCP market in 2007: Spreads

4 Overview I.ABCP programs are like banks II.ABCP programs differ by credit, liquidity, sponsor, and other features III.Measuring “runs” IV.Explaining runs V.Summary and implications

5 The ABCP market Stylized transaction:

6 ABCP programs are like banks, but no deposit insurance Issues short-term debt to finance assets, such as receivables, loans, and securities Assets are longer-term and more illiquid than liabilities Assets are opaque Investor wants funds on demand at par Substantial portion of liabilities is ‘overnight’ Liquidity is achieved by limiting assets to higher quality, shorter maturity, or explicit liquidity support

7 ABCP programs vary by assets and liquidity support Program TypeAssetsLiquidity support Number of programs Market share (Jul 2007) Multi sellerReceivables, loansTypically Full 9845 Non-mortgage single seller Credit-card receivables, auto loans Partial4011 Mortgage single seller Mortgages and MBSPartial112 Securities arbitrage Highly-rated long-term securities Full3513 Structured investment vehicles (SIVs) Highly-rated long-term securities, including MBS Practically None 357 CDOsHighly-rated long-term securities Partial364 Hybrid and other

8 ABCP program also vary by sponsor and other features Sponsors –Domestic commercial banks –Foreign commercial banks –Nonbank sponsors – mortgage lenders, finance companies, asset managers Extendibility Rating

9 Data and methodology Transaction-level data from DTCC for all programs in the U.S. market in ,762 primary market transactions by 340 programs over 251 trading days  Issuer name, amount, maturity, and issue rate Weekly data on maturity distribution of outstandings Supplement with data from Moody’s on type of program, ratings, sponsor, and liquidity support characteristics Estimations based on about 300 programs with paper maturing each week

10 Measuring runs Define a run on an ABCP program as occurring if a program is unable to issue new paper to fund maturing obligations

11 Runs in ABCP Programs

12 Runs are “absorbing states” after August 2007

13 Explaining runs: Methodology Similar to literature on traditional bank runs: Gorton (1988), National Banking Era crises Calomiris and Mason (2003), 1930s failures Primary hypotheses: H1: Runs are related to program fundamentals Credit or liquidity risks H2: Runs are indiscriminate and related to broader market risks Even programs with sound fundamentals can be run if investors are concerned about the ability of banks to meet their commitments Or if investors are less-than-fully informed

14 Explaining runs: Methodology Coefficients on program fundamentals vary by month (m) Sample: program between August and December 2007

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18 Program-specific variables

19 Time dummies

20 Explaining runs: Additional evidence Estimate for two samples: August-September October-December

21 Explaining runs: Additional evidence

22 Risk spreads indicate runs reflect difficulties in issuing, not less willingness

23 Summary ABCP programs are subject to runs Runs were related to fundamentals, but also indiscriminate (variation not explained by fundamentals) in initial weeks In later weeks, runs were mostly discriminating based on fundamentals. Why were good programs run? –Investors may not know actual credit exposures or asset- liability mismatch of each program –Even fully-informed investors may run good programs because concerned that banks will be called on to meet explicit and implicit commitments, and they cannot support the whole market

24 Implications Widespread runs not entirely explained by program-level fundamentals suggest that the ABCP market is inherently unstable Banks need to consider their exposures to explicit and implicit off-balance sheet commitments, and spillover effects Public sector is exposed to runs in the shadow banking system because there may not be enough private capital to purchase all the assets

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26 Market behavior at the onset of financial turmoil

27 Market behavior at the onset of financial turmoil

28 Distribution of overnight ABCP spreads

29 Distribution of overnight ABCP spreads

30 Distribution of overnight ABCP spreads

31 Distribution of overnight ABCP spreads

32 Spreads for different program types

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