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Contraction of the Asset-Backed CommercialPaper MarketAnother credit market that contracted in 2007 was the asset-backedcommercial paper (ABCP) market. As of January 16, 2008, the ABCP marketwas an $800 billion market, roughly 45 percent of the $1.8 trillion U.S.commercial paper market, which itself is roughly one-fifth the size of the$9 trillion U.S. corporate bond market. Corporations issue short-term loans,called commercial paper, to smooth temporary fluctuations in cash flows; thecommercial paper market is one market for short-term financing for firms.For example, suppose a firm needs to make certain seasonal payments andhas a current cash flow constraint. The firm issues commercial paper intothe market in exchange for cash, then repays the loan in 30 or 60 days. Thisloan is unsecured in that it does not specify collateral in case of default. Forblue-chip firms, default is unlikely. However, any firm that defaults on acommercial paper loan is almost surely on the brink of bankruptcy becausethe default signals to the market that it doesn’t have enough cash to pay offthe most immediate of its financial obligations.Commercial paper that is secured by assets (such as a firm’s receivables,auto loans, or mortgage-backed securities) is known as asset-backed commercialpaper. For example, if an automobile manufacturer sells cars but doesnot receive payment for the cars for 1 month, its receivables account willdocument the expected cash flow 1 month into the future. Therefore, abank can issue to the market commercial paper backed by the receivables ofthe firm. If the firm defaults on its obligations, the holder of the ABCP canreceive some payment from the receivables of the firm.Usually, ABCP is issued by a special-purpose vehicle or conduit sponsored bya bank that buys assets—such as receivables from multiple corporations—andissues commercial paper backed by these assets to the outside market. BecauseABCP conduits issue short-term debt to finance longer-term assets, theymust continue to issue new commercial paper to repay maturing commercialpaper (a process called rolling). Special-purpose vehicles can provide corporationswith relatively low-cost access to the short-term financing available incommercial paper markets. These vehicles are not subject to the regulatorycapital charge that is mandated for banks that extend credit directly toborrowers. For example, a bank that makes a direct loan to an automobilemanufacturer would have to hold capital against that loan. But a bank thatsponsored a special-purpose vehicle (which it did not own) could keep themanufacturer as a customer (and earn some fees) without bearing the creditrisk of a direct loan and without facing a capital charge. Structured investmentvehicles (SIVs) are a type of conduit that issues both commercial paper andmedium-term notes to finance the purchase of assets. SIVs differ from ABCP64 | Economic Report of the President