What’s the matter with money?
Really, there is nothing wrong with money. The problem becomes what to do with your cash when faced with a global credit crisis. In the latter half of August, Canadian mining companies were struggling to reassure their shareholders that all is not lost, despite delays in the repayment of asset-backed commercial paper (ABCP) loans.
The root of the problem is the U.S. housing market. Until a year ago the U.S. economy was booming along, driven by consumer spending. Much of the spending was fuelled by home loans. Mortgage lenders expanded their holdings in the subprime sector. “Subprime” in this context means loans carrying higher interest rates made to individuals with less-than-ideal credit histories.
With the promise of real property behind them, these mortgages have become ABCP. They are used as short-term investments by companies needing to withdraw cash as they spend it, for example, on mine developments. ABCP carries a small premium on the interest rate for depositors.
But the U.S. housing market began to unravel this summer, thanks in part to defaults on subprime mortgages. Lenders have been accused of luring homeowners into taking such loans by offering “teaser” rates. The interest rates are artificially low at the beginning of the term, but rise, often steeply, at a point in the future.
Some subprime borrowers found the increased payments too much to handle and walked away from their homes. House prices fell as inventory rose. Lenders found that in many cases the value of the mortgage they had made outstripped the value of the house. Thus, the growth of the U.S. economy based on consumer spending could not be sustained.
What no one realized until mid-August was the extent of investors’ exposure to the subprime market. ABCP had been rolled into what are called collateralized debt obligations, which became in turn part of other investment packages sold around the world. On a pessimistic day, economists say there was US$1 trillion worth of exposure to these types of investments. More optimistic souls use a figure of US$120 billion for the ABCP market. Therein lies one of the major sources of recent market volatility: The Unknown.
The current crisis was triggered as it became known that some of the ABCP underwriters were delaying payout of the deposits. That sent the share prices plummeting of Canadian mining companies with large amounts of cash invested in ABCP. They have since recovered most of their value, but the dip provided buying opportunities for sophisticated investors.
The ABCP deposits are being paid out; a late payment is not the same as no payment. Mines will be built, and the global financial markets will weather this storm.
CMJ readers should refer to the website of any company they are interested in. Many are disclosing their exposure or lack of exposure to ABCP in press releases. In looking at the figures, our readers should consider not only the dollar amount of these deposits but calculate the percentage of total cash they represent, or compare the figures to total capitalization. Additional inquiries may be made through a company’s investor relations contact.