Yesterday, I wrote about the basics of Asset Backed Commercial Paper (ABCP) and how the problem came to be. Today I’ll be focusing on who’s to blame in this mess.

Many investors are focusing their frustration on their brokers. Nobody calls their broker and asks to buy Random Trust #1, they have all been sold to clients as good places to park cash and earn a little extra interest. So now that things have gone wrong, the broker becomes the immediate target. They sold the product.

It would be the broker’s fault if they had sold clients ABCP out of good faith. If they took undue risk and pushed it as something it wasn’t. But they didn’t. These products were all rated highly by firms like DBRS, whose sole purpose is to evaluate the credit rating and risk of products. If these firms would have done adequate work, there wouldn’t be a major problem.

Over the past 6 month, the largest story in the Canadian investment industry has been the collapse of the Asset Backed Commercial Paper (ABCP) market. A lot has been written, very little explained. So let’s bring it down to into ‘normal speak’ and go over the fundamentals:

There are two types of ABCP:

First party issues: These are the products that are distributed by the Big Five Canadian banks. Because Canadian banks have deep pockets and don’t like negative press, they provide liquidity by purchasing the positions that they cannot sell, keeping the market alive. The result? The market keeps chugging along and clients can take advantage by getting over 5% on short term liquid investments during last fall.

Third party issues: This is what has been in the news. Smaller dealers got involved in this market by distributing their own ABCP and since they don’t have the deep pockets of banks, ended up with a frozen market. Now there’s a fight over what to do with these positions that nobody wants.

One of the problems with ABCP is that the products are sold as ‘trusts’. Investors have no clue what are in these trusts. Heck, the brokers are just as clueless. Many of the third party issues were full of risky US mortgage market exposure. When the subprime market blew up, so did third party ABCP. Could you have known? Nope. Could your broker have known? Nope. Is there something VERY VERY VERY wrong with that? You bet!

So who’s to blame? The answer is very simple. And I’ll write about that tomorrow.