Today, we excerpt again from the recently-released "Financial Crisis Inquiry Report," a 633-page report published to "examine the causes, domestic and global, of the current financial and economic crisis in the United States." (See our Jan. 28 Crane Data News, "Financial Crisis Inquiry Report Reviews Disruptions in Funding, MMFs", which covers the early subprime worries through the disaster that was Credit Suisse Institutional Money Market Prime Fund.) We feature pieces of the report mentioning money funds from the Fall of Bear Stearns to the Bankruptcy of Lehman Brothers.
On "The Fall of Bear Stearns (page 280) in March 2008, the report says, "After its hedge funds failed in July 2007, Bear Stearns faced more challenges in the second half of the year. Taking out the repo lenders to the High-Grade Fund brought nearly $1.6 billion in subprime assets onto Bear's books, contributing to a $1.9 billion write-down on mortgage-related assets in November. That prompted investors to scrutinize Bear Stearns's finances. Over the fall, Bear's repo lenders -- mostly money market mutual funds -- increasingly required Bear to post more collateral and pay higher interest rates. Then, in just one week in March 2008, a run by these lenders, hedge fund customers, and derivatives counterparties led to Bear's having to be taken over in a government-backed rescue."
On page 293, under the chapter "March to August 2008: Systematic Risk Concerns," the FCIC writes, "The most pressing danger was the potential failure of the repo market.... Moreover, if a borrower in the repo market defaults, money market funds -- frequent lenders in this market -- may have to seize collateral that they cannot legally own. For example, a money market fund cannot hold long-term securities, such as agency mortgage–backed securities. Typically, if a fund takes possession of such collateral, it liquidates the securities immediately, even -- as was the case during the crisis -- into a declining market. As a result, funds simply avoided lending against mortgage-related securities. In the crisis, investors didn't consider secured funding to be much better than unsecured, according to Darryll Hendricks, a managing director and global head of risk methodology at UBS, as well as the head of a private-sector task force on the repo market organized by the New York Fed."
Under "September 2008: The Bankruptcy of Lehman," the report writes, "On July 10, Federated Investors -- a large money market fund and one of Lehman's largest tri-party repo lenders -- notified JP Morgan, Lehman's clearing bank, that Federated would 'no longer pursue additional business with Lehman,' because JP Morgan was 'unwilling to negotiate in good faith' and had 'become increasingly uncooperative' on repo terms. Dreyfus, another large money market fund and a Lehman tri-party repo lender, also pulled its repo line from the firm."
It continued, "Fed Chairman Bernanke told the FCIC that government officials understood a Lehman bankruptcy would be catastrophic: We never had any doubt about that. It was going to have huge impacts on funding markets. It would create a huge loss of confidence in other financial firms. It would create pressure on Merrill and Morgan Stanley, if not Goldman, which it eventually did. It would probably bring the short-term money markets into crisis, which we didn't fully anticipate; but, of course, in the end it did bring the commercial paper market and the money market mutual funds under pressure. So there was never any doubt in our minds that it would be a calamity, catastrophe, and that, you know, we should do everything we could to save it."
"What's the connection between Lehman Brothers and General Motors?" Bernanke asked rhetorically. "Lehman Brothers' failure meant that commercial paper that they used to finance went bad." Bernanke noted that money market funds, in particular one named the Reserve Primary Fund, held Lehman's paper and suffered losses. He explained that this "meant there was a run in the money market mutual funds, which meant the commercial paper market spiked, which [created] problems for General Motors."
The Financial Crisis Inquiry Report continued, "As the financial industry came under stress," [Henry] Paulson told the FCIC, "investors pulled back from the market, and when Lehman collapsed, even major industrial corporations found it difficult to sell their paper. The resulting liquidity crunch showed that firms had overly relied on this short term funding and had failed to anticipate how restricted the commercial paper market could become in times of stress."
It continued, "Harvey Miller testified to the FCIC that '`the bankruptcy of Lehman was a catalyst for systemic consequences throughout the world. It fostered a negative reaction that endangered the viability of the financial system. As a result of failed expectations of the financial markets and others, a major loss of confidence in the financial system occurred.'"
