It was the restructuring nobody liked. But four years after the asset-backed commercial paper crisis, the deal hammered out to defuse the $30-billion bomb in Canada's financial sector is working out just fine.
In the summer of 2007, a debt crisis not unlike the one now spreading in Europe left Canadian investors, who were holding $30-billion of notes they thought were safe, suddenly facing the prospect of huge losses.
The market for asset-backed commercial paper froze in mid-August, 2007. Panic in European credit markets and concern about exposure to subprime mortgages caused investors to stop buying ABCP in what turned out to be one of the first manifestations of the global credit crisis. That left existing ABCP holders with no way to get their money back.
That left the holders of the $30-billion in limbo. Their money wasn't gone – yet – it was just locked up. The holders faced a strong possibility, however, that unless somebody found a solution, the complicated derivatives trades behind the paper would collapse and their money would indeed be gone. Mining companies, individual investors and huge financial institutions were all in the same boat, though that didn't stop them from squabbling over how to fix the leak.
It took more than a year, and last-minute government help, to put in place a plan to get investors their money back. Like a lot of the emergency restructurings resulting from the credit crisis, from General Motors Corp. to the TARP, the ABCP fix was messier than a 14-year-old's room. Some would say it smelled just as bad.
The settlement talks dragged on and on for more than a year, leaving investors with the old, frozen paper for far longer than anyone expected as steadily worsening credit markets prompted revisions.
The process involved interminable sessions in the Ontario Superior Court as the proponents and opponents fought in front of a judge, and messed up more than one Christmas for all involved as the parties raced for year-end deadlines. It took until early 2009 for investors to get new, tradable paper to replace the old notes.
Nobody was really happy because everyone had to make significant compromises. Investors had to take seven-year notes back for their supposedly short-term paper. Banks that sold the derivatives that backed the paper had to take on more risk.
The restructuring created a market for the paper, allowing owners who needed cash immediately to sell, though anyone who did had to take a loss. Investors who bought the paper in the days after the restructuring have profited handsomely as the fear has come out of the market. A fund run by GMP Capital that invests in ABCP has returned 18 per cent since its inception in November of last year.
The danger isn't totally gone. If credit markets in Europe and the United States get worse, the new notes could still fall apart and investors could face large losses. However, under the restructuring deal, things would have to get much worse – so much worse that ABCP would be the least of our problems.
That's not to say the stakes aren't big. There are some sizable holdings out there. National Bank of Canada still carries $2-billion of ABCP on its balance sheet. The Caisse de dépôt et placement du Québec valued its holdings at almost $8-billion, most of that in the form of restructured notes.
There were, of course, flaws. Critics point to the fact that one group of institutions may have gotten off lightly – the banks (mostly foreign) that sold derivatives to the companies that issued the ABCP, and those that didn't honour promises to provide emergency loans when the emergency came.
There were flaws in most every one of the fixes of the 2007-08 leg of the financial crisis. They were the financial equivalent of what battlefield doctors call meatball surgery. You do what you can. The point is to ensure the patient lives, even if the scars are ugly.
General Motors Corp. is still selling cars, the U.S. banking sector is mostly back on its feet and investors in ABCP are getting their money back, if a whole lot more slowly than they anticipated when they bought what was then pitched as short-term paper.