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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.

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.


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.

By the end of that August week, stunned bankers, regulators and investors - thrown together in what would be called the Montreal Accord - managed to avert a total meltdown by completely freezing $33-billion of the most troubled ABCP. But the door to a two-decade boom of financial engineering had been slammed shut, and in the coming months, reputations would be scarred and decades-old relationships frayed. Since the August crisis, more than $500-million of charges have been announced, including $135-million yesterday by Bank of Montreal.

While few market participants or central bank officials are willing to discuss the crisis in public, a Globe and Mail investigation has found:

Some banks continued to sell ABCP in the weeks prior to the August meltdown even though many buyers were unaware of troubling warning signs that were evident to banks and discussed at senior levels.

One bank was worried enough to stop selling a leading brand of ABCP.

At least two banks warned the Bank of Canada of trouble in the week before the freeze, although no apparent intervention resulted.

The Caisse de dépôt et placement du Québec spearheaded a plan on Friday, Aug. 10, to head off the crisis of the following Monday, but then puzzlingly disappeared from the market when that day came.

What is clear is that in the face of a financial meltdown, the Bank of Canada, foreign and Canadian commercial banks and institutional investors such as the Caisse had to make snap decisions that had profound effects on investors and the Canadian economy. But since then, many investors - big and small - have been left to wonder why little of this behind-the-scenes turmoil was ever explained to them as they purchased paper.

"If that is accurate, it is a big deception," said André Belzile, chief financial officer of Quebec pharmacy chain Jean Coutu. His company bought $35.7-million of asset-backed commercial paper from Aug. 2 to Aug. 10 from National Bank of Canada, its bank of 45 years.

"They never," Mr. Belzile said, "mentioned a thing."


In the early hours of Aug. 13, even with no buyers, there was still hope that the market could be revived. Mr. Pascoe and Mr. Davis retreated to an office next to the trading floor to activate a doomsday rescue plan that few believed would ever be needed.

The help they needed that day was supposed to come from emergency loans known as liquidity support agreements, which were designed to bail out investors in the unlikely event of a market disruption. The only time ABCP issuers had ever seriously contemplated using liquidity loans was in late 1999, when investors worried that Y2K computer problems would shut down the market, a fear that never materialized.

Mr. Pascoe and his team knew they would have to move quickly. Strict protocols set out in loan contracts typically require ABCP issuers to notify their banks of loan requests by 11 a.m. Mr. Pascoe first called the Frankfurt headquarters of Deutsche Bank AG to catch executives before their work day ended. The second call was to the Toronto headquarters of Canadian Imperial Bank of Commerce.

Agreements with both big banks were expected to act as insurance policies. After all, three National Bank sponsored conduits - going by the names of Ironstone, Silverstone and MMAI - had been paying interest to Deutsche Bank and CIBC for years in exchange for the promise that they would lend money when disaster struck. Similar arrangements were working elsewhere, notably in Europe and the United States where banks had agreed to lend money under liquidity agreements to support their troubled ABCP.

As National Bank was about to be reminded, however, the liquidity loans in Canada had a unique condition that gave banks more wiggle room to walk away from these pacts. To qualify for emergency funds, Canadian trusts that issued ABCP had to prove there had been a "general market disruption." National executives were confident that the flight of investors from $33-billion of non-bank ABCP qualified as a general disruption. "There was a very clear expectation that the banks would fund," said one person close to National Bank Financial.

Technically, as the banks told National that afternoon, there had been no general disruption in Canada because the country's largest ABCP issuers, about $90-billion of trusts run by the Big Five banks, were still apparently selling their paper. As one of the banks said in a note to National Bank Financial that day: "We refer you to the definition of general market disruption; this element of the test has not been satisfied."

About two dozen Canadian ABCP trusts - run by smaller banks such as National and finance companies such as Toronto's Coventree Inc. - were already in trouble. They had sent SOS notices to domestic and foreign banks, seeking emergency money from loans that backed about two-thirds of their $33-billion of outstanding paper.

There was breathing room with the remaining notes, known as extendibles, because their maturity dates automatically extended after a default. But unlike the Big Five banks, this group of smaller players did not have the money to repay tens of billions of dollars owed to investors when the non-extendible paper came due.

There was no good answer. If banks on the other end of the liquidity agreements agreed to lend, they risked damaging their own financial health. Denying emergency loans, however, would trigger other troubles.

The trading desks of a number of foreign banks and some of Canada's biggest, including Royal Bank of Canada, CIBC and Bank of Nova Scotia, had been earning commissions for years by selling to clients ABCP issued by smaller independent trusts. If banks denied emergency loans, they would be harming scores of customers, many with relationships that spanned decades.

Against this tense backdrop, the startled banks went in different directions.

Around dinnertime, National got the answer it did not want. CIBC and Deutsche Bank both said no: There would be no lifelines thrown to the sinking market.

Other banks let it be known they would not open their vaults, either. RBC turned down a request by Skeena Capital Trust, another ABCP conduit.

According to people familiar with the decisions, these banks concluded there had been no general market disruption under the terms of their liquidity agreements because investors were still buying bank-issued ABCP.

The view was not universal. In Toronto, a team led by John Schumacher, Scotiabank's head of global capital markets, examined the morning's crisis and the wording of the bank's loan contract with Skeena. Scotiabank agreed to a bailout. Across the Atlantic, officials at Dutch bank ABN Amro and British lender HSBC PLC made the same call, advancing money to Skeena.

"It's our view that it's absurd to think that what we saw that day was anything but a general disruption," said Scotiabank spokesman Frank Switzer.

Regardless, as evening fell, most of the trusts knew there was not enough money to revive the market. And within days, the devastating chill of a frozen market filtered from the upper reaches of bank towers to the offices of treasurers and comptrollers across Corporate Canada, where the arcane financial product was about to become a wrench in the wheels of industry.

At Goldfarb Corp.'s offices in Toronto's leafy Annex neighbourhood, there was not a trace of turmoil when chief financial officer Karen Killien arrived at work at the holding company on that Monday morning. In fact, Ms. Killien had come to work early because more than $20-million of Goldfarb's holdings of ABCP was coming due that day. For tax reasons, she wanted to shift money into shorter-term investments known as banker's acceptances. And so, she placed a call to the Toronto trading desk at Scotiabank, the company's bank for 40 years, to reinvest $17-million of the maturing commercial paper in the so-called BAs.

By her recollection, there was no mention during the brief conversation of the morning's dramatic exodus of ABCP investors.

The bank did not call again until Wednesday.

"I've got some bad news for you," a manager told Ms. Killien.

The company's ABCP notes had not been repaid on Monday, meaning Goldfarb Corp. had no money to pay for the $17-million of BAs it ordered. Scotiabank would cancel the trade, but her company would be stuck with the frozen paper.

A shaken Ms. Killien walked into the office of her boss, Martin Goldfarb, with Alonna Goldfarb, the pollster's daughter and in-house lawyer. They had to break the news to a man who became famous advising Pierre Trudeau.

"How is this possible?" Mr. Goldfarb asked the pair.


A meltdown like this wasn't supposed to be possible. When financial engineers in the United States first started "securitizing" corporate assets in the mid 1970s, the products were designed to help companies shave borrowing costs, and to offer investors new options.

The paper appealed to a huge cross-section of buyers who need short-term places to park money - from miners sitting on cash until they needed to buy equipment or money market funds wanting to increase their returns.

The structures worked like this: A pool of assets such as car loans was transferred by companies to a separate subsidiary or trust, which in turn sold securities or debt notes to investors. The notes paid interest from the cash flow generated by the assets. So, the car loan or mortgage payments went to the trust, which in turn paid interest to its commercial paper holders. Any difference counted as profit for the trust. That is, until someone stops paying their mortgage.

As the global economy boomed, the repackaging of debt - and with it, the mass distribution of risk - became so prevalent and so profitable that soon most of the world's major banks were in the game. Financial institutions loved bundling their loans and selling them as securities because it reduced their potential exposure to bad debts. That freed up more money to make more loans. And even better, securitization generated fee income.

For the investors buying the stuff, the slightly higher interest rates - "juice" in trader lingo - easily beat conventional debt notes, because the risk seemed about the same and major financial institutions were behind the products.

In Canada, the first asset-backed commercial paper arrived in 1989 when CIBC created RAC Trust.

Right from the beginning, investors were told little of how the trusts worked, or what was in them.

"Disclosure was dismal," said Daryl Ching, a former Coventree employee who is now working as an independent consultant in the field. "I've seen the investor reports and ratings agency reports. But by the same token, investors were satisfied with that same type of disclosure for more than 20 years that the industry had in place. They've had a lot of time to demand more disclosure."

To entice wary investors, the financial engineers tried to build in plenty of insurance against disaster. The trusts had a cushion of extra assets, so that many would have to go bad before it caused any noticeable loss to holders.

"Everyone was very conservative, from a credit perspective," said Huston Loke, head of global structured finance at DBRS, the Canadian company that blessed the emerging genre of commercial paper with solid credit ratings. "You had belts, suspenders, nets."

And if investors stopped buying, there was always the backup credit line - those liquidity agreements from the big banks.


Remarkably, in hindsight, the market grew up with almost nobody watching out for investors. Commercial paper started as a much simpler investment - essentially an unsecured IOU sold by a company looking to raise short-term cash. Buyers were generally institutional investors. From the earliest days, market overseers took a hands-off approach, arguing that it was a business with sophisticated buyers and sellers who could take care of themselves.

When ABCP made its debut, provincial securities agencies showed little interest because the trusts issuing the paper were not public firms.

That left the Office of the Superintendent of Financial Institutions (OSFI), the federal bank regulator, as virtually the only cop in the Canadian ABCP market. One problem: That regulator is concerned solely with avoiding a collapse in banks. It gave no thought to ABCP investors.

In Canada, it fell to a team of officials in the Ottawa headquarters of OSFI to set down in print what would become the defining rules of the local ABCP game. In 1994, OSFI came up with a 10-page guideline known only by the dry bureaucratic title "B-5." Today, it's frequently blamed for the August traumas.

At the time, U.S. and European bank regulators had decided that the prospects of an ABCP default were so remote they needn't require banks to set aside any capital reserves to cushion against possible losses on backup loans. But OSFI looked at the landscape, and worried its foreign counterparts were being too cavalier.

And so, a Canadian wrinkle was born.

According to OSFI, the only way Canadian banks could sidestep capital reserves for liquidity loans was if they inserted a clause stating that the emergency funds could be drawn only if there was a general market disruption. In effect, the regulator was saying that with B-5, banks had to ensure the likelihood of lending money was virtually nil.

Rod Giles, an OSFI spokesman, said the regulator added the condition to ensure the banks were properly protected against market turmoil.

"The use of securitization started to grow rapidly, and after a period of time, OSFI identified increased risk to banks that offered to loan to securitization structures with less than one-year commitments," he said.

The meaning of general market disruption wasn't clearly laid out, leaving banks free to negotiate terms. In the early days, some contracts defined general market disruption as a shutdown of 90 per cent of the total Canadian ABCP market. Others set a threshold of 30 per cent.

Canada's approach was so different that two of the world's biggest rating agencies decided not to grade Canadian ABCP. In a prophetic 2002 report, Standard & Poor's argued the market disruption terms were "narrow to the point of being almost meaningless."

Toronto-based DBRS went ahead and rated the paper, believing the liquidity provisions were well known. DBRS's Mr. Loke said investors generally weren't concerned with them anyway. Instead, they wanted DBRS to focus on the credit quality of the assets underlying the trusts.

"The attention all the way along," he said, "was on credit."


The nature of the credit risks was getting vastly more complicated, thanks to an innovation in the market pioneered in large part by Coventree.

The firm arrived on the scene in 1998, founded by three industry veterans eager to challenge a decade of big bank dominance of the securitization business.

Through the hustle of Bay Street lawyers Geoff Cornish and David Ellins, and former IBM securitization specialist Dean Tai, Coventree won business by focusing on smaller clients and securitizing new types of assets. In 2001, the company earned a meagre $34,000.

But as it brought new ideas to the Canadian market, such as extendible commercial paper, profits started to soar, and so did Coventree's profile in the industry.

The firm attracted employees with an entrepreneurial culture that was a tonic to those who had worked in the stuffy offices of big banks. There was also a strong current of competition springing from the energetic Mr. Tai, on view in fierce matches over the office foosball table, where he was known to call time-out in a close game to draw up a winning play.

"It was an environment that fostered creativity and innovation," said Mr. Ching, who had previously worked at RBC. "At Coventree, when I had an idea for a new asset class or a new client, they'd say 'Go with it. Run with it.' "

The firm vaulted into the top ranks of ABCP creation, trailing only Bank of Montreal and CIBC in market share. By the time of its initial public offering in 2006, the firm had 56 employees, profit of $22.5-million and offices looking out on Toronto's storied Bay Street and the bell tower of Old City Hall.

Stock market investors took notice, as Coventree shares soared from the IPO price of $10.75 to a high of $16.30 just prior to the market's meltdown.

One of the big drivers of growth for Coventree, and all the independents, was the creation of trusts backed not only by traditional assets such as loans, but by more complex financial assets.

The goal was the same, to create income to pay ABCP holders, with some left over for the operators of the trusts. Bankers on Wall Street and Bay Street had a seemingly perfect fit. Basically, trusts would become insurers against corporate bond defaults, using derivatives contracts. In return, the trusts would get a regular income stream.

The contracts for the first time exposed ABCP investors to the vagaries of international credit markets. And if the market value of any underlying loans deteriorated, the trusts could be hit with margin calls and forced to raise fresh money.

Nonetheless, investors ate up the derivative-backed paper, though because of the "don't ask, don't tell" nature of disclosure in the ABCP business, it's questionable how much they really knew about what they were getting. ABCP backed by derivatives rose from $5-billion in 2003 to $35-billion in June, mostly in trusts run by independent, non-bank issuers such as Coventree.

By late 2006, however, the enormous success of derivative-backed ABCP led some financial engineers to design shakier financial structures. These products were risky enough to prompt DBRS in January to effectively shut down this class of investments by denying them its top ratings.

The about-face was devastating to Coventree. "I believe the situation we find ourselves in is analogous to a tsunami coming," Mr. Tai said in a Feb. 1 e-mail. Adding further stress to the small financial company was an internal turf war that erupted into a lawsuit. When the legal battle was settled in July, Coventree lost a number of its top managers, including Mr. Ellins who opted for a new career as a mystery writer.

When Monday, Aug. 13, arrived and the market froze, Coventree had more riding on the answers to loan requests than anyone. Big banks such as BMO and CIBC had other lines of business, and could easily absorb a shutdown in the market. Coventree could not.

As the bells at Old City Hall tolled the hours, the replies rolled in. There were some lenders that said "yes," but too many that said "no." The banks would not save the day for Coventree, or the owners of its paper.

David Allan, Coventree's head of capital markets, watched in disbelief. "Here was a market that I had been involved in for 17 years, that I had had a role in building, that was now turning a corner into chaos."


Without a trigger, none of those design flaws in ABCP might have mattered.

The fatal crash for Canadian ABCP investors came from an unexpected angle - the collapse in the U.S. housing market. Through a kind of financial alchemy, investors all around the globe owned chunks of the risk posed by foreclosures and defaults on U.S. subprime home loans to dodgy borrowers.

Banks that made the loans had packaged them into bonds, and some of the bonds were the basis of derivatives contracts like those used by the newest style of ABCP trusts.

As the housing bust made bigger and bigger headlines, Coventree's principals tried to head off any problem. The firm sent out a bulletin in mid-March and held investor meetings to explain that Coventree's trusts had just 7 per cent of their assets invested in subprime-related securities and derivatives.

The housing problem only got worse as summer began, and investors were getting increasingly jittery. Coventree made another attempt to head off a blowup.

On July 24, Judi Dalton, a Coventree executive, sent a note to the banks that sold Coventree ABCP in order to update the market on the amount of subprime mortgages backing Coventree's $16-billion of trusts. The total: 4 per cent.

"At Coventree we are committed to furnishing our investors and dealer partners with the information they need to continue to support us through market cycles," Ms. Dalton wrote. "Many thanks for your continued support."

Instead of soothing nerves, the missive had the opposite effect. Nobody wanted to see any subprime at all. That wasn't the only problem. Some dealers felt they were in an awkward situation - Coventree had told them something that the world at large didn't know. Sources said at least two of the banks, RBC and Scotiabank, pushed to have the details made more widely known, perhaps via a press release.

When that didn't happen, RBC went further. On Friday, July 27, representatives of the bank, including RBC's head of fixed income and currencies for Canada, Peter Dymott, called David Allan to say the bank was giving Coventree the required 30 days' notice to resign as a seller of its paper.

"We pro-actively made the decision to resign after discussions with Coventree which failed to address our concerns," Mr. Dymott said. "We felt that our investor clients were not being well served and that our resignation was the right choice."

When word seeped into the market that the country's biggest bank had stopped selling the paper, the simmering crisis of confidence moved closer to a boil.


Not long after Judi Dalton's July 24 attempt to shore up the Canadian market, events in Europe and the U.S. turned very dark, making it almost certain that Canada's ABCP market would run into trouble.

In Germany, investors stopped buying paper from Rhineland Funding, which had subprime exposure and was set up in a similar way to a Canadian ABCP trust. Rhineland was forced to call to emergency lenders with a plea for €12-billion. One of the backing banks didn't have the money and nearly failed, forcing a high-profile bailout.

A full week before Canada's problems climaxed, U.S. ABCP issuers with subprime assets were for the first time forced to tell holders they wouldn't get their money back on time. Canadian ABCP was still selling, but only at higher and higher interest rates.

Amid all this turmoil, one of Canada's biggest players, Caisse de dépôt, stood as an enigma. The Caisse was a big buyer of ABCP. It was also an early backer of Coventree, owning 29 per cent of the firm before selling when Coventree went public in November, 2006.

The Caisse was aggressive in its hunt for extra yield, people in the securities industry said, constantly seeking every additional fraction of a percentage point, something that ABCP provided. The math was compelling for the country's largest pension manager. On a portfolio the size of the Caisse's $237-billion in assets under management, even one extra hundredth of a percentage point means almost $24-million a year in returns.

The Caisse became by far the largest buyer of ABCP issued by the independents such as Coventree, controlling as much as a third of the market, according to bank executives. That concentration worried many in the industry, because any loss of appetite by the Caisse could rock the market.

According to market participants, that's exactly what happened in the month or so before Aug. 13: The Caisse started scaling back ABCP purchases. The Caisse has declined to talk about its trading, though people close to the fund have said there was no strategic decision to reduce holdings of ABCP.

Whatever the reason for any selling, the perception spread that the biggest buyer was losing faith. Then, the Caisse made a 180-degree turn. In the first week of August, as shockwaves from Europe roiled the market, the Caisse waded back in to prop up ABCP sales. According to people familiar with the fund's trading, the Caisse began to buy tens of millions of dollars of ABCP that otherwise would have gone unsold.

As that week drew to a close, it was clear a crisis was coming. Demand was steadily weakening as the market hurtled toward Monday, Aug. 13, when more than $1-billion of non-bank ABCP was coming due. On top of that, there was talk of a large amount of new issuance of ABCP hitting the market from big bank-sponsored programs. Supply would swamp demand.

The Caisse, large as it was, could not hold up the market alone. The giant money manager put out a cry for help, and on Friday, Aug. 10, representatives from banks, DBRS and issuers gathered at the Caisse's glass-sheathed headquarters on the edge of Old Montreal to find a way to forestall the crisis.

Led by Luc Verville, a vice-president with responsibility for money markets at the Caisse, the participants hatched a three-step plan to keep the market rolling, according to people who were there. DBRS would review the health of each trust and notify the market if all the assets were sound; dealer banks would agree to keep buying and selling paper, and to hold unsold ABCP on their own balance sheets if necessary; and Coventree and one other independent trust sponsor, Newshore Capital, would commit to sell assets from some trusts in order to raise cash and thereby increase their margin of safety.

Mr. Verville also urged participants to call the Bank of Canada to ask for assistance. There was a good feeling that with the help of the Caisse, the central bank and the new plan dubbed the "soft-landing proposal," the market would get through Monday.


In Ottawa, the central bank had spent the week leading up to Aug. 13 getting up to speed on the situation. There were few experts on ABCP, leaving some at the Bank of Canada scrambling as the market went into fits, calling trusted traders and Wall Street contacts to ask for explanations of what was happening, and how such credit instruments were structured and traded.

The central bank wasn't in a receptive mood when the requests for help started to come in, in part because the bank didn't have much sympathy for holders of the ABCP.

The nature of the loan backstop arrangements was no secret. The central bank had previously pointed out the weaknesses of the Canadian system, and left the rest up to investors.

That caveat emptor approach was a constant, both in the period leading up to the August market breakdown, and after. In the central bank's estimation, investor ignorance was the source of the problem, and it wasn't the bank's job to bail out investors who didn't do their homework.

"It was very sloppily understood and researched by the investors," said one Ottawa official, who declined to be named. The central bank also saw serious problems with many of the proposed solutions coming from the private sector. The idea of the central bank stepping in to buy paper that went unsold was deemed laughable. Using emergency lending powers to provide liquidity to banks so that they could backstop the failing conduits was also inappropriate. Any emergency funding is to be used only to bail out solvent financial institutions that are having liquidity issues, officials at the central bank argued.

The market had one last suggestion: The central bank could accept ABCP as collateral for loans to banks. The view from sellers and dealer banks was that such a move would improve confidence in the paper by giving it a stamp of approval, and enable banks to hold more ABCP because they could borrow against it. Again, the central bank said no, arguing that no clear value could be put on the ABCP and the bank should not be in the business of bailing out specific market sectors.

Still, Ottawa was not totally hands-off. Federal officials relied on moral suasion - the bureaucratic term for arm twisting. Bank of Canada Governor David Dodge and Mark Carney, the number two bureaucrat in the Department of Finance and a former investment banker from Goldman Sachs, burned up the phone lines with key CEOs. (Mr. Carney has since been named to replace Mr. Dodge on Feb. 1, partly because of the respect he earned during the crisis.)

Mr. Dodge in particular was adamant that the market clean up after itself. "The responsibility lies on the investor and if he or she takes risks, they should expect to benefit if things turn out very well, and should be expected to pay the costs when things turn out not so well," he told reporters in September, after the crisis had peaked.


Without help from the Bank of Canada, the "soft-landing" proposal was the last hope. But as Aug. 13 dawned, it was clear the plan wasn't going to work, for one simple reason: There were no buyers. Even the Caisse was not rolling paper, something that stunned people who knew that the pension fund had tried only three days before to salvage the market.

Tuesday, Aug. 14, was little better in the market, and the risks were mounting. Trusts had only a three-day grace period before they would begin to default. There would be a fire sale of assets in tumbling markets, and ABCP investors would have no chance of getting all their money back.

Someone needed to pull the market back from the abyss. That someone was Henri-Paul Rousseau, the burly, mustachioed head of the Caisse. According to people familiar with the Caisse, Mr. Rousseau spent most of Monday and Tuesday calling government officials, banks and other ABCP investors.

"He was a force of nature during those days," said one person who worked alongside Mr. Rousseau. "He just kept putting the calls out and telling people what needed to be done." He had to persuade ABCP investors that it was in their best interests to pursue a restructuring.

By Tuesday afternoon Mr. Rousseau had persuaded National Bank, Desjardins Group and PSP Investments, the Montreal-based manager of federal employee pensions, to join forces with the Caisse. That night, officials from the institutions, now known as the "Original Four," worked until 2 a.m. to complete a one-page proposal calling for investors and banks to declare a temporary truce. Under the terms, nobody would force defaults, nobody would sue, and nobody would make further calls for loans. If successful, the deal would buy time to restructure the ABCP notes into more solid investments.

The trick now was to get the rest of the players to sign on, especially the big banks such as Deutsche Bank that had provided many of the liquidity agreements and the derivatives trades at the heart of the crisis.

The call went out for another meeting at Caisse headquarters. Bankers again scrambled on short notice for planes to Montreal to make it by early Wednesday afternoon.

When they arrived, participants made their way through the Caisse's soaring atrium to a main-floor conference room known only as B101, which, according to one person in attendance, bore a remarkable resemblance to a bingo hall.

Mr. Rousseau dominated, pushing all to set aside their differences. In the group, or in quiet individual asides, he kept coming back to one point: Work together or the market will implode, leaving everyone in the room with huge losses, both in cash and reputation.

The meeting dragged on through dinner - takeout chicken and fries that Mr. Rousseau ordered from Quebec's iconic St-Hubert chain - and late into evening. It wasn't until after midnight that a truce was reached. Mr. Rousseau had his ceasefire.


Three months later, a few of the market's ailments have been treated, but most persist and time is running short to find a cure. The truce ends in just four weeks.

DBRS has demanded that all Canadian ABCP trusts scrap "general market disruption" language and move to "global-style" backup loan contracts that make it easier to force banks to pay up in a pinch. More troubling, the value of most ABCP remains unknown. Coventree has laid off 30 per cent of its staff and its stock languishes at just over $1 a share.

Less measurable but not less important, the bonds of trust between some companies and their banks have been shattered. "We don't understand what's going on in our markets any more and we feel we can't trust anyone," said Dwayne Lo, comptroller of First Quantum Minerals Ltd., which was left holding $10.5-million of Coventree ABCP purchased from HSBC, a bank that First Quantum says it will no longer use. Since August, Mr. Lo said, his company has invested its excess cash only in guaranteed investment certificates or banker's acceptances.

All is not lost. The restructuring of one of the frozen ABCP issuers, Skeena Capital Trust, is almost finished and most investors may get all their money back. As for the other 21 trusts, a group of banks and big investors, including the Caisse, is still seeking a solution that would swap the troubled notes for something more solid and long-term. Steadily worsening credit markets and an atmosphere poisoned by finger-pointing and suspicion make it a difficult task.

Nonetheless, Purdy Crawford, a lawyer who at age 76 remains Canada's most respected corporate Mr. Fix-it, is confident he can lay out a plan to get investors as much of their $33-billion back as possible.

He knows that if he fails, the trusts will have to be unwound and their underlying assets sold into an already fearful market. Every major bank in the world would feel the effects.

But if he succeeds, the financial damage will be contained to a bruising, and the asset-backed paper debacle will be remembered as a painful lesson on the perils of the new world of finance. It's a world where dozens of disparate risk factors come into play thanks to financial instruments such as derivatives. It's a world where an investment in a seemingly simple and safe security really means a stake in a home loan in Atlanta, a corporate debt in London and a derivative tied to global credit markets.

In that world, where banks use securitization to sell their loans to investors eager for returns, the buyers of assets such as ABCP have to play the role of credit officers as they examine what's behind the paper. They can no longer rely on banks, which are offloading their risks, to be as picky about the lending they do.

But it's also a world where "black box investments" like ABCP have perhaps become the norm, even though they are difficult to understand or value. Billions of dollars of such black boxes are now crumbling around the world - SIVs and CDOs and other esoteric structures that, like ABCP, go by their initials because their names are too convoluted and confusing.

For investors to understand the perils - to play credit officer - they need to be able to see into the black boxes. Had investors been able to clearly comprehend the workings of Canada's ABCP, they might have known that subprime holdings were minimal. The boycott of buyers, and the frozen market that resulted, could potentially have been avoided.

The blame for the lack of transparency rests on many shoulders. Investors didn't ask, sellers didn't tell, and regulators who focus on traditional stocks and bonds didn't push either side of the market to have an honest conversation about risk.

Blowups in the financial system are nothing new, and there will be more. But during those three days in August, more transparency and a better understanding of this new financial world would have enabled the banks, the buyers and the regulators to at least minimize the damage that still haunts Canadian markets.



DBRS became the only credit-rating agency to rate third-party asset-backed commercial paper (ABCP) in Canada, where the emergency funding provisions differed from those that became acceptable in other countries. As the third-party ABCP sector exploded last year, DBRS took measures to reel in some of the riskier practices it was seeing at the beginning of 2007. The rating agency attended the Aug. 16 meeting that led to the Montreal Accord.

Office of the Superintendent of Financial Institutions

OSFI has come under fire for enabling the loophole that made many of the liquidity agreements for ABCP here less robust than those elsewhere. But Julie Dickson, the Superintendent of Financial Institutions, has argued that it was the regulator's role to protect the banks. It did that by allowing the loophole, which effectively meant emergency funding only had to be provided to trusts if there was a disruption in the entire ABCP market.

Caisse de dépôt et placement du Québec

Headed by Henri-Paul Rousseau, the biggest pension fund manager in Canada is also the country's largest holder of third-party ABCP. While it has consistently refused to say how much of the paper it has, sources peg its holdings at about $14-billion.

National Bank of Canada

In an effort to head off any damage to its reputation, the bank announced fairly early on that it would be buying back roughly $2-billion in third-party ABCP from its mutual funds and clients, having recommended the paper as an investment. The bank's money market funds had up to 40 per cent of their assets invested in the sector.

HSBC Holdings PLC

This British-based giant is one of the 10 financial institutions that banded together with the Caisse to conceive a restructuring plan for the third-party ABCP market in August: the so-called Montreal Accord. Its Canadian unit took a small writedown in October related to the $379-million worth of commercial paper it holds. HSBC Bank Canada also sold the paper to numerous commercial clients and was sued in October by Aastra Technologies Ltd., which bought $8.5-million worth.

Coventree Inc.

Founded in 1998 as a competitor to the domestic banks, Toronto-based Coventree is known as an innovative packager of corporate debt. It was set up by a corporate lawyer, Geoffrey Cornish, and a former IBM financier, Dean Tai. The pair got the backing of the Caisse, and started selling short-term commercial paper that was backed by long-term debt, such as mortgages, auto loans and credit card payments. At its peak in the spring, Coventree was worth $270-million.


The Buyer: Government of Yukon

The Holdings: $36.5-million of asset-backed commercial paper (ABCP) sponsored by Coventree Inc.

The Damage: About 15 per cent of Yukon's total cash is locked up in the troubled notes. The territory has no immediate need to recover the investments and has agreed to stand by while the Montreal Accord of investors led by Toronto lawyer Purdy Crawford seeks to restructure the stricken notes.

The Buyer: DundeeWealth Inc.

The Holdings: Almost $400-million of ABCP

The Damage: After Toronto investor Ned Goodman's Dundee Corp. created Dundee Bank of Canada a year ago, it chose ABCP as a place to invest some of the $2-billion of deposits it received from customers drawn to high rates offered on its savings accounts. One month after an ABCP trust sponsored by a Dundee unit was unable to repay investors, Dundee Bank was sold to Bank of Nova Scotia. On Nov. 14, DundeeWealth announced a 15-per-cent or $57-million writedown on its ABCP holdings.The Buyer: New Gold Inc.

The Holdings: $158.9-million of ABCP sponsored by Coventree Inc.

The Damage: The company raised nearly $400-million of debt and equity in June to pay for the construction of its planned New Afton gold and copper mine west of Kamloops, B.C. Near the end of July, New Gold invested 40 per cent of the cash in ABCP to earn interest while the company waited to begin construction on the mine. The company got its mining construction permit Nov. 1 and it currently has enough cash to pay for supplies and about 75 employees at the site.

The Buyer: Jean Coutu Group (PJC) Inc.

The Holdings: $35.7-million

The Damage: Three days after Jean Coutu made its last purchase of $7.4-million of ABCP on Aug. 10, a National Bank of Canada official called to alert the company that repayment of some of the paper had been "temporarily" delayed. A week later, on Aug. 20, a bank official phoned again with the news that there was no money to repay the entire $35.7-million of ABCP. Jean Coutu recently sold its U.S. store chain, so André Belzile, chief financial officer, said the company has no urgent need for the cash.

The Buyer: Sun-Times Media Group Inc.

The Holdings: $48-million of ABCP in trusts sponsored by Coventree and National Bank

The Damage: Could it get any worse for this company? Once the U.S. arm of Conrad Black's newspaper empire, the Chicago company has seen its name and financial health diminished in the wake of its former proprietor's criminal and financial setbacks. In November, its fortunes took another negative turn when it suffered a $4.8-million (U.S.) charge against its ABCP holdings.

The buyer: Redcorp Ventures Ltd.

The Holdings: $90-million in Coventree ABCP

The Damage: Redcorp sold $250-million of debt and equity to investors in July to finance the construction of its planned Tulsequah zinc, copper and lead mine in northern British Columbia. Redcorp won mining permits last month, but $90-million of its cash is locked in ABCP. The stranded notes equal more than 90 per cent of the total $99-million market value of Redcorp's stock.

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