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Chicago Fed Letter, No. 270, January 2010
Rescuing Asset-backed Securities Markets
Asset-backed securities (ABS) are bonds backed by the cash flow of a variety of pooled receivables or loans. Firms issue ABS to diversify sources of capital, borrow more cheaply, reduce the size of their balance sheets, and free up capital. Securities backed by auto loans, credit card receivables, student loans and home equities represent the largest ABS market segments. The ABS market grew dramatically from the beginning of 1998 through 2006, when supply peaked at $888 billion in the U.S. In August 2007, the ABS market began shrinking in stages, with bond issues backed by residential mortgages drying up first, followed by the collapse of both the consumer ABS (auto, credit card and student loan segments) and the commercial mortgage-backed securities markets. After the failure of Lehman Brothers in October 2008, investor confidence was further undermined and yields on ABS skyrocketed. This resulted in large increases in interest rate spreads—i.e., the difference between ABS yields and risk-free yields, such as the Treasury rate and Libor (London interbank offered rate). In the new high-yield environment, there was no economic incentive for lenders to issue new ABS; and the intermediation of household and business credit between investors and borrowers ground to a halt.
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