Although the Canadian banks did not suffer as much as other financial institutions around the world, they were not immune from the economic consequences of the subprime mortgage meltdown. In Canada, the earliest crisis concerned the liquidity of asset-backed commercial paper (ABCP)

that was affected by the precipitous decline of U.S. housing prices and the related mortgage-backed securities on which those prices were based.

ABCP were short-term debt obligations, generally issued by a special purpose entity or trust and secured by a bundle of assets such as mortgages and other types of consumer loans. The repayment and maturity of these ABCPs was dependent on the cash flow of the underlying assets.

The ABCPs were issued to investors by trusts that were sponsored or managed by either banks or nonbank financial institutions.

The nonbank-sponsored portion of the Canadian market was approximately

\($35\) billion.

In July 2007, as the U.S. subprime mortgage market began to deteriorate, the Canadian issuers began to fear that they, too, could face a liquidity crisis that would prevent the recovery of capital or refinancing of borrowings when they came due. As such, in August, a number of nonbank ABCP sponsors agreed to a sixty-day standstill period, called the Montreal Accord, during which the holders

(those who had invested in the ABCP)

promised not to roll over or redeem their paper at maturity, and the issuers agreed not to make any collateral calls. A committee, chaired by Toronto lawyer Purdy Crawford, then began to work out a deal whereby the short-term ABCP could be converted into long-term floating-rate debt that would have a much greater likelihood of recovery or refinance because the underlying assets would eventually recover their value.

The agreement required the support of the five major banks in Canada. They were each to pay \($500\) million in order to shore up the country’s debt market. However, Canada’s third-largest bank, the Toronto-

Dominion Bank (TD), balked at the suggestion on the basis that, three years earlier, the bank intentionally had moved to eliminate its exposure in the nonbank ABCP market.

In May 2005, Edmund Clark, CEO of the TD, announced that the bank would exit the structured loans products market, including interest rate derivatives and collateralized debt obligations such as ABCPs.

The bank decided that it would focus on consumer banking rather than the securities business. Clark, who had a Ph.D. in economics from Harvard, contended that the securities business was too risky. He had been briefed by experts who traded these securities on the nature of credit and equity products and concluded that the risk was too great. “The whole thing didn’t make sense to me. You’re going to get all your money back, or you’re going to get none of your money back. I said ‘wow!’

if this ever went against us, we could take some serious losses here.” The TD generated 80% of its profit from consumer lending and money management. “I’m an old school banker. I don’t think you should do something you don’t understand, hoping there’s somebody at the bottom of the organization who does.”............

Questions:-

1. Because the TD was neither a manufacturer nor a distributor of ABCP products, did the bank have a moral responsibility to assist in the restructuring of the commercial paper market?
2. If you were Edmund Clark, how would you explain to the Board of Directors that you were having the bank exit a market in which your competitors were making a lot of money?
3. The banks in Canada are highly regulated by the federal government. If the banks could not come to a voluntary agreement, should the federal government have forced the banks through legislation to providing \($950\) million financial support to help solve the ABCP liquidity crisis?