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.
While I agree (And said at the time) the TARP is a terrible plan. You assume that the redemptions would have been halted by a Shutdown of withdrawals. Once word got out that the measure was necessary it seems to me demand for redemptions would have syk rocketed you know…. like a run on the bank.
They definitely needed a massive “Show of force” to demonstrate that the government would act decisively in order to head off a run on the bank.
That being said I still don’t see why we didn’t use the $700 bn to buy the excesses supply of houses paying off the mortgage and then tear them down removing the supply from the market.
I agree with Kurt. There was more going on. TARP may not have been the right answer, but it was a flexible answer and the hits were coming at high velocity. I personally could argue that TARP was necessary purely because political buy-in from the Congress was a necessary evil, given the administration’s negotiating position and a pending Presidential election.
I agree with Kurt, in the sense that the Money Market redemption threat was a way of finding out how far the government would go in financially intervening. From the prior Sunday, and the special trading session, many investors knew that, if Lehman went down, Merrill could follow quickly. In other words, a Calling Run ( Debt-Deflation ) was possible. When Lehman hit, the government aided AIG, the B of A bought Merrill, and the government essentially guaranteed Money Market Funds. All of these actions suggest to me that the government understood that we might be in a Calling Run. The mystery is why they have chosen such odd methods to stop it, other than generally admitting that the government is on the hook.
For me, a Calling Run is different than just redemptions in one area. Since no one knew who or how much anyone was committed to mortgages or mortgage related securities, and they could see a huge fall in prices and a tsunami of defaults coming, people started calling in cash in all sorts of investments, some only tangentially connected to mortgages. This also showed in the flight from agencies to treasuries, from implicit to explicit guarantees.
Once a Calling Run begins ( Fisher’s Debt-Deflation ) only the government can stop it, because only the government has the assets available to be believable in easing wipe-out concerns. The government has been trying to do this ever since, but poorly. The whole point of the total guarantee is to stop the run, and allow an orderly exchange of assets and losses, not keep it going, only in slow motion.
I like your plan, and would be inclined to support it, but not here. Again, for me, since many smart people saw this as a possibility, including Bernanke, I simply can’t explain their poor choices.
You know more than me, but that’s how I see it. By the way, paradoxically, even though I believe that we needed to honor these guarantees in this instance, I believe that these implicit guarantees are the main cause of this crisis. In this, I seem to be alone. For me, nothing else explains the risk taken by major banks and investment firms.
Proposal for the Obama Administration:
While they are limiting the salaries of SOME of the bank executives on the government’s dime, I think that they should also limit the salaries of the state executives receiving government aid in the next stimulus. A lot of them make half a million dollars per year (including some deputy governors). I say knock it down to $150,000 per year.
I think businesses need to start looking at generating new opportunities themselves to survive the financial turmoil in the industry. In addition to relying on schemes and bail-out plans, smaller businesses can look towards alternative sources of funding during the credit crunch. Taking a business loan from the company pension scheme is one such way to do generate the much needed finance in harsher times. This is commonly referred to as SSAS loans.
As a quick aside, because I’ve seen this thought being espoused so many times…
why we didn?t use the $700 bn to buy the excesses supply of houses
Housing was in a bubble. The bubble popped when houses became so expensive people could not afford to carry them even under the loosest of terms.
In the biggest bubble locales like S. California the price to income ratio was 6, 8, even 10 times above the historical average of 3-4. Nothing one undertakes regarding supply will make houses more affordable for the people that already overpaid and are now defaulting on their mortgages. This drop in price is a good thing. Unless you wish for us and all future generations to be nothing more than debt slaves in service of our mortgages.