Shortly past 8 a.m. on an already sweltering August Monday, a small team of financiers hurried down a flight of stairs in one of Montreal's most historic office buildings to watch a modern disaster unfold.
The men, senior executives with National Bank Financial, were hurrying to a cavernous room on the main floor of the beaux-arts Sun Life building where more than 100 traders buy and sell billions of dollars of stocks, currencies and debt instruments every day. Leading the group was Ricardo Pascoe, a wiry, soft-spoken derivatives specialist who was named co-chief executive officer of National Bank of Canada's securities arm a year earlier. At his side was his top legal executive, Brian Davis.
Mr. Pascoe whisked the group past long lines of noisy trading desks to a normally quiet corner where a half dozen men and women were feverishly working the phones. The traders were seeking buyers for a Byzantine class of short-term debt called asset-backed commercial paper. Known by the clunky abbreviation ABCP, the paper had become a money market darling in the past decade, accounting for more than 30 per cent of Canada's $360-billion short-term debt market.
The 30-day and 60-day notes paid interest generated by bundles of mortgages, car loans and other debts pooled in special vehicles called conduits or trusts. These conduits were hard to understand, even by many lawyers and bankers, but the lack of transparency never seemed to bother investors, who snapped up the notes because they offered some of the highest interest rates going, boasted the best credit ratings and were sold by the world's leading banks.
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Yet on this morning, investors were beginning to panic that an unknown quantity of toxic subprime mortgages had infected the assets that backed Canadian ABCP.
Mr. Pascoe wanted to witness in person the progress of early trades because tremors had shuddered through the global debt market in preceding days, shaking the usually sedate ABCP market.
Assuming the worst, some investors had balked a week earlier at buying ABCP, making it difficult for some Canadian issuers to raise the money they needed to pay back notes that were coming due. Other ABCP issuers were scrambling for money to meet margin calls triggered by falling asset values. A wave of at least $1-billion of ABCP was coming due that morning. Existing or new investors would have to buy an equal amount of new paper if sellers, including three trusts sponsored by National Bank, were going to be able to raise enough money to repay the maturing notes.
But by the time Mr. Pascoe and his colleagues arrived, it was too late. Ashen-faced traders shook their heads. They had phoned almost all major clients with maturing ABCP to ask how much new paper they wanted to purchase. No one was buying. Not the dozens of pension funds, governments, major companies or wealthy individuals that had been frequent investors. And most surprisingly, not the Caisse de dépôt et placement du Québec, the country's single largest ABCP buyer, which, according to sources, owned more than $14-billion of the notes.
In trading parlance, the commercial paper wasn't “rolling.” One of the fastest-growing segments of Canada's debt markets had just gone into seizure.
“It felt like we were on the edge of an abyss,” said one person on the Montreal trading floor that day, who did not want to be identified, “and we didn't know where it was going to end.”
Aug. 13 was about to become a day of financial infamy.
Chapter 1
BROUGHT TO THE BRINK
This was no ordinary credit crisis triggered by a handful of imprudent lenders or borrowers. The retreat in Canada was part of an international flight of investors from a trillion-dollar global market in asset-backed investments. The panic hit markets everywhere, but Canada was uniquely vulnerable because of a design flaw in its system.
At stake were the savings of a far-flung collection of investors stretching from the Yukon government to credit union branches in Chicoutimi, Que. For three days in August, this massive market was brought to the brink of a national financial disaster. Credit crises come and go, but this time it was corporate treasurers, pension managers and government officials who would have to explain in the ensuing months why they held, even indirectly, delinquent mortgages in the Flint, Michigans of America.
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