The Story Not Told?

I’m tossing this out for comment.  This blog post alleges that US money market funds faced a calamitous withdrawal on 9/18/08, and the US Treasury put a stop to it , and then announced the TARP, etc.

I viewed the recommended video, and indeed Paulson says little, but might hint at bigger things.

But we have better information from the Joint Economic Committee of Congress.  Let me quote from this on page 9:

Breaking the Buck Causes Runs on Money Market Mutual Funds. On Monday September 15, 2008, the $62 billion Reserve Primary Fund, a money market mutual fund, “broke the buck” because of its investment in Lehman Brothers’ short-term debt securities. The Reserve Primary Fund suspended redemptions for one week.

On June 30, 2008, money market mutual funds had total assets of $3.3 trillion of assets. Among these assets, money market mutual funds held $701 billion of commercial paper, or about 40 percent of all commercial paper outstanding. “Breaking the buck” at the Reserve Primary Fund caused investors to question unnecessarily the soundness of other money market mutual funds.

Irrational runs on money market mutual funds began. For the week ending on Wednesday September 17, 2008, investors redeemed $145 billion from their money market mutual funds. On Thursday September 18, 2008, institutional money managers sought to redeem another $500 billion, but Secretary Paulson intervened directly with these managers to dissuade them from demanding redemptions. Nevertheless, investors still redeemed another $105 billion. If the federal government were not to act decisively to check this incipient panic, the results for the entire U.S. economy would be disastrous. [Emphasis mine.]

1. To satisfy redemptions, money market mutual funds slashed their holdings of commercial paper. Commercial paper outstanding fell by $52 billion during the week ending on Wednesday September 17, 2008 as money market funds refused to rollover commercial paper. If this trend continued, major non-financial firms would

a. Lose their primary source for short-term borrowing, and

b. Call upon their back-up lines of credit with commercial banks.

2. Given the extreme funding problems commercial banks were encountering during the week, commercial banks would either:

a. Slash credit to small- and medium-size non-financial firms and households to meet the line of credit commitments to large non-financial firms, or

b. Not be able to fulfill the line of credit commitments to large non-financial firms at all.

3. The result would be a disabling credit contraction that would trigger a severe and lengthy recession with large declines in production and employment, further erosion in household wealth, and a significant increase in the federal budget deficit as countercyclical outlays soared and tax receipts dwindled.

Birth of a Comprehensive Plan. This run forced Chairman Bernanke and Secretary Paulson to reassess the federal government’s previous ad hoc approach to the global financial crisis. Together Bernanke and Paulson concluded a comprehensive plan was necessary to (1) restore confidence and (2) kick start credit markets into functioning again.

To stop the runs on money market mutual funds and to revive the market for commercial paper, Chairman Bernanke and Secretary Paulson acted swiftly on Friday September 19, 2008.1. Secretary Paulson announced a temporary program through which the Treasury will use the $50 billion in the Exchange Stabilization Fund to protect investors in money market mutual funds from any losses should their fund “break the buck” during the next year. Money market mutual funds will pay an insurance premium to the Treasury for this guarantee.

2. The Federal Reserve established two loan facilities to help money market mutual funds meet any demand for redemptions.

a. The Federal Reserve will extend non-recourse loans of up to $230 billion to banks and other depository institutions to buy investment-grade asset-backed commercial paper from money market mutual funds.

b. The Federal Reserve will extend non-recourse loans to primary dealers of up to $69 billion to buy short-term debt securities of Fannie Mae, Freddie Mac, or FHLBs from money market mutual funds.

So is that why our government acted so precipitously?  To rescue the money markets?  That seems to be true, but after a shutdown of withdrawals, the government could have simply quietly bailed out a few funds, and the crisis would have passed.  Instead, they panicked, and opted for an unwarranted wider solution, the TARP.

There would have been better ways to deal with runs on money market and other funds, but the government uses old models in their economic reasoning.