Investors Scrutinizing the Regulators

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ABCP a wake-up call

April 14, 2008

Asset-backed commercial paper, or ABCP. Even the name of this type of financial instrument was fashioned to create the impression of solid and secure value, which we now painfully know was never justified.

Yet rating agencies endorsed ABCP with ratings far higher than it deserved. Brokers flogged it to unsuspecting investors as a safe investment that would earn more than truly safe instruments like government treasury bills. And companies and banks that issued ABCP saw an opportunity to raise low-cost money through risky vehicles.

It is hard to blame investors who got badly burned by this scheme for thinking of it as a tacitly contrived, greed-driven financial conspiracy operating on a grand scale.

But a more useful and productive interpretation of the ABCP debacle would be that it reflects the kind of market failure that occurs in the absence of proper regulatory oversight. Had regulators ensured a proper assessment of the these instruments, their use never would have become as widespread as it did.

Another lesson that has emerged from the ABCP crisis is that regulations of the various parts of the financial system must be knitted tightly together because distinctions among the players bond and stock issuers, banks, brokers, security exchanges and rating agencies tend to blur in highly integrated financial markets.

But co-ordinated regulation is especially difficult in Canada, where the constitutional division of powers over financial matters is poorly suited to the complexities of modern finance. At a time when the world's seven richest countries are looking for ways to collaborate in strengthening regulatory oversight of integrated, international capital markets, Canada is the only country that does not have a national securities regulator; instead, it has separate provincial regulators.

Federal Finance Minister Jim Flaherty has said, with some justification, that these provincial securities regulators deserve some of the blame for the ABCP problems in Canada. One more reason why this country needs a national securities regulator.