The Evolution of a Financial Crisis: Panic in the Asset-Backed Commercial Paper Market

Abstract

The $350 billion contraction in the asset-backed commercial paper (ABCP) market in the last five months of 2007 played a central role in transforming concerns about the credit quality of mortgage-related assets into a global financial crisis. This paper attempts to better understand why the substantial contraction in ABCP occurred by measuring and analyzing runs on ABCP programs over the period from August 2007 through December 2007. While it has been suggested that commercial paper programs, like commercial banks, may be prone to runs, we are the first to conduct a comprehensive empirical analysis of runs in the ABCP market using a rich and novel issue-level data set for all ABCP programs in the U.S. market. A program is defined as being run when it does not issue new paper during a week despite having a substantial share of its outstandings scheduled to mature, and then continuing in a run until it issues. We find evidence of extensive runs: more than 100 programs (one-third of all ABCP programs) were in a run within weeks of the onset of the turmoil and the odds of subsequently leaving the run state were very low. We interpret this finding as an indication that the ABCP market was subject to a bank-like "panic." We also find that while runs were linked to credit and liquidity exposures of individual programs, runs were also related importantly to non-program specific variables in the first several weeks of the turmoil, indicating that runs were relatively indiscriminate during the early part of the panic. Thus the ABCP market may be inherently unstable and a source of systemic risk.

The Federal Reserve and the 2007–2009 Financial Crisis: Treating a Virus with Antibiotics? Evidence from the Commercial Paper Market

“…Thus, CP provided almost 40% of the funding of Countrywide's trading assets just prior to the financial crisis and the crisis dramatically reduced their access to this funding. Covitz, Liang, and Suarez (2009) note that about one‐third of asset‐backed CP programs failed to roll over their issues within a week in the late 2007.…”

The Hazards of Debt: Rollover Freezes, Incentives, and Bailouts

“…We fix φ to be consistent with the duration of a 30-year mortgage that has a yield and coupon of 6.5%, or roughly φ = 0.075. We begin with an expected debt maturity of 1/δ = 0.1 years, or around 37 days, consistent with the average maturity of ABCP in March 2007 (Covitz, Liang, and Suarez (2009)). We choose θ = 5 to give us θδ = 50, which translates into an expected survival time of 1 φ+δθ = .02 years, or approximately one week, during a freeze.…”

“…We conclude by briefly examining how our computed optimal maturity compares with empirical data. Covitz, Liang, and Suarez (2009) establishes that the average maturity of ABCP issued by conduits in 2007 had an average maturity of around one month, and that this if anything shortened towards the end of 2007. Here we also examine the maturity debt of 10 US primary dealers in 2006, as few empirical studies focus on the debt maturity of large financial firms.…”

The Mortgage and Financial Crises: The Role of Credit Risk Management and Corporate Governance

“…This was particularly true for the monoline mortgage finance companies such as New Century Financial, a firm that grew into a large mortgage finance company principally through subprime lending and filed for Chapter 11 bankruptcy in April 2007. 9 Covitz et al (2009) demonstrate that ABCP programs are subject to a bank-like panic. For example, Bear Stearns revealed in June 2007 that it spent $3.2 billion to bail out two of its hedge funds exposed to the subprime market-the largest bailout of the fund by a bank in almost a decade.…”