[MUSIC] The precipitous drop in the amount of asset-backed commercial paper outstanding that we saw in the figure in the previous lesson, going to recall it a run. It's a run on asset-backed commercial paper programs just like you can have a run on a bank. A run on a bank is when suddenly, the depositors in that bank decide I'm not sure if the bank is gonna be able to pay us back. The bank has long-term assets, like the mortgage loans that it has made but short-term liabilities. And if the total value of those assets is not the total value of those liabilities, then they won't be able to pay me or any depositor back. So, I'm gonna go to that bank, I'm gonna take my money out. An asset-backed commercial paper program has a run that goes pretty much the same way. The program itself has assets, often securitized bonds that it has purchased, and it has liabilities, which are short-term, not demand deposit, perhaps, 90 day paper. So when my paper comes due, when I'm asked to take the 90 day loan that I've made and just re-up, roll it over it is called. The simplest thing for me to do if I am nervous about the underlying solvency of the program is to say, no thank you. A formal definition of this is given in an important paper by Covitz, Liang, and Suarez, three economists at the Federal Reserve Board. Who define an asset-backed commercial paper run specifically as a week when the program does not issue any new commercial paper, despite the fact that at least 10% of the outstanding commercial paper currently in the program has matured. So we observe a program has a certain amount of commercial paper. At least 10% of it is coming due, typically, what you do would be roll that paper but we don't observe that they've issued any commercial paper. That would make it appear that they're unable to roll it. Now this won't be a perfect definition but it's gonna capture almost all of the cases that we care about. What Covitz, Liang and Suarez show is that these runs became endemic in August 2007. And that once a program experienced a run, once there was a week where it was not issuing commercial paper, even though it had appears that some of their commercial paper had expired, they are unlikely to ever leave that state. It's unlikely to see them ever issue anything else. By December 2007, more than 40% of the programs were in a run state. Here's a picture that shows that. The fraction of all asset-backed commercial paper programs that are experiencing runs. This number is not zero in the pre-anxiety period and that's just because the measure that they have is not perfect. It's a somewhat coarse measure. Occasionally, a program, even when it's healthy, might not issue even though it would appear that they're having some of their commercial paper expire. Think of that as a baseline level of about 5%, or less than 5%, that really aren't runs. But everything else above that, starting in August, as the line increases very rapidly, are actual runs. Now this doesn't happen to all programs and it doesn't happen to all programs right away because not all programs had any possible exposure to subprime. There are some programs that very explicitly said, all we're going to buy are things that have nothing to do with mortgages. Those programs generally should stay safe. But if you're involved in anything where there's uncertainty about whether or not there is any subprime bonds in your portfolio, then you were in danger of the run. The more jagged line tells us that if you are in a run in the previous week, what is your probability of actually leaving the runs state? You can see this is pretty high in the early years and that's because the run states, again, are probably not real run states. But once we hit August 2007, and the programs that are unable to issue debt or that do not issue debt really are in real trouble, we see it becomes very unlikely for those programs to actually exit. So, once you have entered the run state, that is usually it. You are not going to be issuing more commercial paper. What happens, then, to these programs? If they're unable to roll them, then they must call upon the liquidity support, the promise, the backup lines of credit, which are very often from banks, and from their sponsoring banks. So think for a moment about what this means. Looking now at the total amount of asset-backed commercial paper outstanding. By the end of 2007, it's down approximately $350 billion from it's peak just before BNP Paribas, 1.2 trillion at it's peak, and then down by the end of 2007 by about 350 billion. So where does all of that debt go? These securities are still owned. The asset-backed commercial paper programs still have all of this stuff and still need to finance it somewhere. But, no longer can they finance it with unsecured borrowings by the programs themselves. Instead, the liquidity support providers, most often the banks, need to start lending the money themselves. Where do they get it? They get it either from the interbank markets, which as we know are stressed and are now charging 50 to 100 basis points higher than they did pre-BNP Partibas. Or they have to take the actual collateral and send it out into the market as a collateralized loan of some kind. Either way, there is pressure now on financial institutions which used to be receiving a source of funding largely from money market mutual funds and other lenders that are restricted to only purchasing short term debt. And they now need to run into the markets to find a place, to find a source of financing, either secured or unsecured, that is different. That's what we mean when we say there is pressure on interbank markets. And we can quantify that pressure here as being approximately $350 billion worth over the last few months of 2007. [MUSIC]
