Collapse of the Asset-Backed Commercial Paper Market

The Evolution of a Financial Crisis:

Collapse of the Asset-Backed Commercial Paper Market*

DANIEL COVITZ, NELLIE LIANG, and GUSTAVO A. SUAREZ

April 5, 2012

ABSTRACT

This paper documents “runs” on asset-backed commercial paper (ABCP) programs using a novel dataset of all transactions in the U.S. market during its severe contraction in 2007. We find that one-third of programs were run within weeks of the onset of the ABCP crisis and that runs, as well as yields and maturities for new issues, were related to program-level and macro-financial risks. The findings are consistent with the asymmetric information framework used to explain banking panics, have implications for the degree of risk-intolerance of commercial paper investors, and inform upon empirical predictions of recent papers on dynamic coordination failures.

Keywords: Asset-backed commercial paper, runs, financial crisis JEL Codes: G01, G10, G21

*

All authors are at the Federal Reserve Board. This paper represents the views of the authors and does not necessarily represent the views of the Board of Governors or other Federal Reserve staff. We are deeply indebted to two anonymous referees, Campbell Harvey (the editor), and an associate editor for detailed feedback that greatly improved the paper. We thank seminar participants at the Federal Reserve Bank of San Francisco, the Yale Conference on Financial Crisis Research, the IADB-LFN, the IMF, and the Bank of Canada, Viral Acharya, Franklin Allen, Adam Ashcraft, Markus Brunnermeier, William Dudley, Gary Gorton, Zhiguo He, Jeffrey Lacker, Eduardo Levi-Yeyati, Peter Lupoff, Gregory Nini, Philipp Schnabl, Jeremy Stein, and Wei Xiong for useful comments. We also thank Scott Aubuchon, Elisabeth Perlman, and Landon Stroebel for excellent research assistance.

Since the mid 1980s, banks have moved an increasing volume of assets off their balance sheets and funded them through asset-backed commercial paper (ABCP) programs, bankruptcy remote “paper companies” that issue short-term debt in the commercial paper market.1 Traditionally, ABCP programs financed receivables from nonfinancial companies, but over time they increasingly financed a wider range of assets, including highly rated mortgage- and other asset-backed securities. By the end of 2006, ABCP outstanding in the United States had grown to $1.1 trillion, larger than the amount of unsecured (non-asset-backed) commercial paper outstanding and a significant part of the U.S. shadow banking system.2

However, in the summer of 2007, ABCP outstandings began to plummet. The proximate cause of the contraction was mounting concerns about the default risk of subprime and other mortgages. Outstanding ABCP shrank by $190 billion, almost 20%, in August, and yields soared and maturities shortened for new issues. Outstanding ABCP fell by an additional $160 billion by the end of the year (see Figure 1). The deep contraction likely contributed to the broader financial crisis because banking institutions sponsored and provided liquidity and credit support to ABCP programs, and because securitization markets relied on ABCP for funding, and so were likely adversely affected by the contraction in ABCP.

[Figure 1 about here]

In this paper, we study the collapse of the ABCP market in 2007 in order to better understand the framework behind financial panics, as well as to improve our understanding of the risk intolerance of commercial paper investors, and to shed light on a distinguishing assumption in recent theories of coordination failures in short-term credit markets.

Our analysis exploits a rich data set based on all transactions and amounts of paper outstanding at ABCP programs in the U.S. market in 2007. The data are proprietary information from the Depository Trust and Clearing Corporation (DTCC) on the prices, quantities, and

maturities of almost 700,000 transactions by 339 ABCP programs, as well as weekly information on the maturity structure of program-level outstandings. These data are supplemented by hand-collected information from reports by major rating agencies on the type of program and the identities of the sponsors and liquidity providers, to create a dataset that is unparalleled in detail about ABCP programs.

The focus of our analysis is on the measurement and determinants of “runs” on ABCP

programs.3 A program is defined as entering a run during a week in which it does not issue despite having 10% or more of its outstandings scheduled to mature; the program continues in a run until it issues again. The empirical analysis of runs considers a rich set of potential determinants, including program risk characteristics, program type, sponsor type, and macro-financial variables. In addition, we conduct an empirical investigation of the yield spreads and maturities of new issues for programs not in a run.

The main empirical results are as follows. First, a substantial number of ABCP programs

experienced a run in the last five months of 2007. About 30% of programs were in a run within weeks of the onset of the ABCP crisis and nearly 40% of programs, more than 120 programs, were in a run at the end of 2007, and the odds of exiting a run were very low. Moreover, declines in outstandings at programs experiencing runs accounted for most of the drop in ABCP outstanding in 2007. Second, runs in the crisis were not random but instead were significantly more likely at riskier programs, based on observable program characteristics, program type, sponsor type, and macro-financial variables. Third, for the programs that could issue, yield spreads and maturities of new issues had explainable variation during the crisis, and the determinants were similar to those that help to explain runs.

These results are consistent with previous findings from studies of bank panics that runs

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