The size of the ABS commercial paper market is big. Very big. And its very size is a problem in the market. Money managers are declaring they don’t own the stuff, never had it in their portfolios, don’t understand it, and if they did they would not have bought it. Yet, this cannot be true for the market as a whole. Just like all Boston’s baseball fans could not have been in Fenway Park when the Red Sox beat the Yankees in 2004, everyone could not have avoided the ABS market. It is just too large. The chart shows that the ABS market is larger than non-financial CP debt outstanding. In fact, it has surpassed the total debt in both the financial and non-financial sectors. Who is holding this paper? How is it going to roll?
To say that all ABS CP is bad is the height of financial profiling. It is just not the right thing to do, but in situations of high uncertainty this type of profiling is done. The key public policy issue right now is to have the government help stop this profiling. The Fed and other government services should help banks and rating agencies provide distinctions in this paper. If the Fed is willing to take CP collateral it should help distinguish haircuts. This will relieve the market uncertainty. Of course, some CP issuers of poor quality programs may not want the market to distinguish between good and bad credits. This is an information problem which needs to be solved not by regulation but through cooperation. Note that this is like all asymmetric information problems. I am thinking about the classic “lemons” and cars problem. The prices across all used cars are affected if the quality cannot be distinguished. Better information allows for a better functioning market.
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