Inside the Meltdown: Who Was Withdrawing From Money Market Funds On September 16-18, 2008 and Why?
“If the American people ever allow private banks to control the issue of their currency, first by inflation and then by deflation, the banks and the corporations that will grow up around them, will deprive the people of all property until their children wake up homeless on the continent their fathers conquered.”
The short answer is financial institutions to avoid possible losses on their most liquid and supposively safe assets, their money market funds.
But was something else going on and if so who really was behind the run on the money market funds.
Watch the Front Line Documentary Inside the Meltdown on February 17, 2009 or online:
Some preview clips are provided below together with background videos:
FRONTLINE investigates the causes of the worst economic crisis in 70 years on WMFE TV!
Front Line Documentary Inside the Meltdown
FRONTLINE | Inside the Meltdown | Sneak Peek 1 | PBS
FRONTLINE | Inside the Meltdown | Sneak Peek 2 | PBS
Money Market Funds In Jeopardy
In-Depth Look: Money Market Funds
In-Depth Look: Money-Market Funds
Congressman: US came within hours of economic collapse; Banks saw $550 billion withdrawn in 2 hours
1/3) Tom Woods: Meltdown (Lew Rockwell Show 2/11/09)
2/3) Tom Woods: Meltdown (Lew Rockwell Show 2/11/09)
3/3) Tom Woods: Meltdown (Lew Rockwell Show 2/11/09)
Turmoil in the Cash Markets: Did Enhanced Cash and Money Market Strategies Overdo Risk?
“…The recent event that had the greatest impact was the Lehman Brothers bankruptcy on September 15. Most financial markets experienced a tremendous shock and it had a profound ripple effect on money markets as well: it indirectly drove a very large money market fund to “break the buck.” The Reserve Primary Fund held over one percent in Lehman commercial paper and when investors got wind of it, they decided to redeem en masse. That same week, AIG, a major international insurance company, ran into trouble and was bailed out by the government.
Following these historic events, corporate spreads widened dramatically, especially in the financial and banking sector. The commercial paper issued by many large, high-quality issuers traded as though every financial was going out of business. Banks stopped lending to each other and the cash markets were frozen. Before this crisis, prime money market funds, which held mostly commercial paper, were thought to be just about the safest investments in the market. But investors quickly understood that prime funds were no longer immune to the credit crunch because of their corporate exposure, and they fled to only the safest assets – Treasuries.
Government Takes Action to Assist Money Markets
The U.S. government had to take dramatic steps to address the problems in the money market arena:
First, they needed to stop the run on the bank. Too many redemptions in prime money market funds would cause a feedback loop and more prime funds might break the buck. Therefore, the Treasury established a temporary money market guaranty program recently extended until April 30, 2009, and eligible to holdings held as of September 19 to stop the run. This program insures money market assets of those funds that enroll and pay a small premium of assets.
The next step was to create liquidity in the commercial paper markets: the Federal Reserve established the AMLF, or Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, which gives banks financing to buy high-quality ABCP from money market funds through January 2009.
Another step was needed to create liquidity in the unsecured commercial paper market. The New York Fed launched the Commercial Paper Funding Facility (CPFF), a special purpose vehicle funded by the Fed which will buy highly rated asset-backed and unsecured commercial paper directly from U.S. issuers. So far, this facility has helped add liquidity for direct issuers and reduce the LIBOR-OIS spread.
These steps still hadn’t addressed the sale of commercial paper in the secondary market, so the Fed also agreed to provide up to $540 billion in loans to money market funds beset by redemptions. This program, the Money Market Investor Funding Facility (MMIFF), launched in late November and helps mutual funds sell term commercial paper on the secondary market. We expect this to free up more liquidity.
Money Market Funds
Money funds (or money market funds, money market mutual funds) are mutual funds that invest in short-term debt instruments.
Money market funds, also known as principal stability funds, seek to limit exposure to losses due to credit, market and liquidity risks.[clarification needed] Money market funds, in the United States, are regulated by the Securities and Exchange Commission’s (SEC) Investment Company Act of 1940. Rule 2a-7 of the act restricts investments in money market funds by quality, maturity and diversity. Under this act, a money fund mainly buys the highest rated debt, which matures in under 13 months. The portfolio must maintain a Weighted Average Maturity (WAM) of 90 days or less and not invest more than 5% in any one issuer, except for government securities and repurchase agreements.
Eligible money market securities include commercial paper, repurchase agreements, short-term bonds or other money funds. Money market securities must be highly liquid and have a stable value.
Breaking the buck
“…Money market funds seek a stable $1.00 net asset value (NAV); they aim to never lose money. If a fund’s NAV drops below $1.00, one says that the fund “broke the buck”.
This has rarely happened; however, as of 16 September 2008, two money funds have broken the buck (in the 37 year history of money funds) and from 1971 to 15 September 2008, there was only one failure.
The Community Bankers US Government Fund broke the buck in 1994, paying investors 96 cents per share. This was the first failure in the then 23 year history of money funds and there were no further failures for 14 years. The fund had invested a large percentage of its assets into adjustable rate securities. As interest rates increased, these floating rate securities lost value. This fund was an institutional money fund, not a retail money fund, thus individuals were not directly affected.
No further failures occurred until September 2008, a month that saw tumultuous events for money funds.
- See also: Financial crisis of 2007-2008
The week of 15 September 2008 to 19 September 2008 was very turbulent for money funds and a key part of financial markets seizing up.
On Monday, 15 September 2008, Lehman Brothers Holdings Inc. filed for bankruptcy.
On Tuesday, 16 September 2008, Reserve Primary Fund, the oldest money fund, broke the buck when its shares fell to 97 cents, after writing off debt issued by Lehman Brothers.
On the same day, BNY Institutional Cash Reserves, which was not a money fund, but a securities lending fund run by BNY Mellon, also broke the buck – its NAV fell to 99.1.cents – also due to Lehman holdings.
The resulting investor anxiety almost caused a run on the bank for money funds, as investors redeemed their holdings and funds were forced to liquidate assets or impose limits on redemptions: through Wednesday, institutional funds saw net outflows of $173 billion to $2.17 trillion, a withdrawal of over 7%. Retail funds saw net inflows of $4 billion, for a net capital outflow from all funds of $169 billion to $3.4 trillion (5%). The lack of retail outflows is attributed to the lag required for individuals to open a new account, to transfer their funds out and retail funds expected significant withdrawals the following week.
On Thursday, 18 September 2008, Putnam Investments’ Prime Money Market Fund, a $15 billion institutional fund, announced that it was liquidating, due to redemption pressures.
In response, on Friday, 19 September 2008, the U.S. Department of the Treasury announced an optional program to “insure the holdings of any publicly offered eligible money market mutual fund — both retail and institutional — that pays a fee to participate in the program.” The insurance will guarantee that if a covered fund breaks the buck, it will be restored to $1 NAV. This program is similar to the FDIC, in that it insures deposit-like holdings and seeks to prevent runs on the bank. The guarantee is backed by assets of the Treasury Department’s Exchange Stabilization Fund, up to a maximum of $50 billion. It is very important to realize that this program only covers assets invested in funds before 19 September 2008 and those who sold equities, for example, during the recent market crash and parked their assets in money funds, are at risk.
The program immediately stabilized the system and stanched the outflows, but drew criticism from banking organizations, including the Independent Community Bankers of America and American Bankers Association, who expected funds to drain out of bank deposits and into newly insured money funds, as these latter would combine higher yields with insurance.
The crisis almost developed into a run on the shadow banking system: the redemptions caused a drop in demand for commercial paper, preventing companies from rolling over their short-term debt, potentially causing an acute liquidity crisis: if companies cannot issue new debt to repay maturing debt, and do not have cash on hand to pay it back, they will default on their obligations, and may have to file for bankruptcy. Thus there was concern that the run could cause extensive bankruptcies, a debt deflation spiral, and serious damage to the real economy, as in the Great Depression.
The drop in demand resulted in a “buyers strike”, as money funds could not (because of redemptions) or would not (because of fear of redemptions) buy commercial paper, driving yields up dramatically: from around 2% the previous week to 8%, and funds put their money in Treasuries, driving their yields close to 0%.
This is a bank run in the sense that there is a mismatch in maturities, and thus a money fund is a “virtual bank”: the assets of money funds, while short term, nonetheless typically have maturities of several months, while investors can request redemption at any time, without waiting for obligations to come due. Thus if there is a sudden demand for redemptions, the assets may be liquidated in a fire sale, depressing their sale price.
An earlier crisis occurred in 2007–2008, where the demand for asset-backed commercial paper dropped, causing the collapse of some structured investment vehicles. …”
Recent Money market collapse almost drove the world into another great depression
This development could have significant ramifications for the entire money market mutual fund industry, which is based on confidence in the complete safety of the “buck.” Jeff Bobroff, mutual-fund consultant in Rhode Island, stated, “This is going to unsettle investors and probably create further runs on other money funds.” Experts fear that investors’ concern about the sanctity of money market funds could result in widespread withdrawals that would further aggravate the global credit crisis. Money market funds are major buyers of short-term debt issued by corporations and financial companies and significant withdrawals from money market funds could severely disrupt that market.
Over the past year, various money market funds have actually seen their assets’ value fall below $1/share but money market fund sponsors have provided capital infusions to avoid the money market funds’ “breaking the buck.” Legg Mason, SunTrust, Morgan Stanley, Charles Schwab, Wachovia, Bank of America, and Credit Suisse are among the firms that have supported their money market funds in this manner.
Background Articles and Videos
Money Market Funds Enter a World of Risk
“…On Tuesday, the Reserve Primary Fund, a giant money market fund whose parent helped invent that investment, said its customers would lose money. Instead of each share being worth a dollar for every dollar invested, it said its customers’ shares were worth only 97 cents. In Wall Street parlance, it “broke the buck,” a rare occurrence.
So far, it appears that no other money market funds have fallen below a dollar a share. And other money market managers have hastened to reassure investors that their money is safe. But the Primary Fund’s announcement did raise this question: What, in today’s world, is truly safe?
After all, the Primary Fund’s troubles did not occur in isolation. They followed the disappearance of both Lehman Brothers and Merrill Lynch, not to mention the government bailouts of the mortgage finance giants Fannie Mae and Freddie Mac and the insurance company American International Group. And if you haven’t already forgotten, there was the failure of the California thrift IndyMac in July.
And that’s why, in this market, financial advisers agreed on Wednesday, consumers need to become their own chief investment officers, even when it comes to something as simple as finding a place to put their cash. …”
The arrangement bore the same relation to actual finance as fantasy football bears to the N.F.L. Eisman was perplexed in particular about why Wall Street firms would be coming to him and asking him to sell short. “What Lippman did, to his credit, was he came around several times to me and said, ‘Short this market,’ ” Eisman says. “In my entire life, I never saw a sell-side guy come in and say, ‘Short my market.’”
And short Eisman did—then he tried to get his mind around what he’d just done so he could do it better. He’d call over to a big firm and ask for a list of mortgage bonds from all over the country. The juiciest shorts—the bonds ultimately backed by the mortgages most likely to default—had several characteristics. They’d be in what Wall Street people were now calling the sand states: Arizona, California, Florida, Nevada. The loans would have been made by one of the more dubious mortgage lenders; Long Beach Financial, wholly owned by Washington Mutual, was a great example. Long Beach Financial was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking homeowners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000. …”
Peter Schiff The Henry Hazlitt Memorial Lecture 13th March 2009 1 of 2