Everyone knows that one of the immediate catalysts of the near systemic collapse in the aftermath of the Lehman bankruptcy, one which set in motion the sequence of events that led to Bernanke increasing the Fed's balance sheet fourfold, was when the Reserve Primary Money Market Fund announced on September 16 that the value of its shares had dropped to 97, sparking an epic run on money market funds, and requiring an immediate bailout first from its sponsor, and then the Federal Reserve and US government. What is far less known is that the Reserve Primary Fund was just one of many money market funds that got locked out and was in danger of collapse following the decision to let Dick Fuld hang. How many? According to a research note released by the NY Fed itself, at least 28 more!
As Marco Cipriani et al report, "at least twenty-nine MMFs had losses large enough to cause them to break the buck in September and October 2008 despite significant government intervention and support of the sector. Five funds or more experienced losses exceeding the 3 percent reported by Reserve, and one fund reported a loss of nearly 10 percent. Among the twenty-nine funds that would have broken the buck without sponsor support, the average loss was 2.2 percent.
The NY Fed report continues by suggesting what is well-known: that in a time of crisis, nobody wants to point out that the emperor is naked, or that the money market fund has broken the buck:
Yet, the losses for twenty-eight of these MMFs may have gone unnoticed during the crisis, as neither their shareholders nor almost anyone else could have observed their magnitudes at the time. As in other episodes in which MMFs suffered significant losses, the losses were absorbed—and hence obscured—by voluntary financial support from MMF sponsors (the MMFs’ asset management firms or their parent companies). The extensive record of sponsor support for MMFs does allow us to look back to the 2008 crisis and other periods of strain for indirect evidence about funds’ losses. In a 2010 report, Moody’s found 144 cases in which U.S. MMFs received support from sponsors between 1989 and 2003. Brady, Anadu, and Cooper (2012) documented 123 instances of support for seventy-eight different MMFs between 2007 and 2011, including thirty-one cases in which support was large enough that it probably was needed to prevent funds from breaking the buck. Still, these data only allow estimates of what MMF losses must have been to motivate sponsors’ actions.
Alas, the "sponsor support" was not sufficient, and required a wholesale bailout. The report continues:
In contrast, the data we describe are market-based values of MMF portfolios reported confidentially by the funds themselves during the crisis to the Department of the Treasury (“Treasury”) and the Securities and Exchange Commission (SEC). In general, these “shadow” net asset values (NAVs) are invisible to investors and the public, as MMFs are permitted to round their reported share values to $1 so long as the shadow NAV remains above $0.995. Only if the shadow NAV drops below that threshold does the fund break the buck—unless it receives sponsor support. During the crisis, many MMFs did receive such support, so their shadow NAVs remained invisible. However, any MMF with a shadow NAV below $0.9975 that participated in Treasury’s Temporary Guarantee Program for MMFs was required to report to Treasury and the SEC what its shadow NAV would have been without some forms of sponsor support, such as capital support agreements. Since virtually the entire industry participated in the program, these data provide an unprecedented record of MMFs’ portfolio losses at the time.
Said otherwise, the primary investment vehicle for some $3 trillion in assets suddenly found itself insolvent. And this is merely the first thing that Bernanke, Paulson, the bank CEO and everyone else failed to grasp when less than a week prior they decided to let Lehman brothers fail. Of course, since nothing has changed since then but merely the amount of excess liquidity sloshing in the system, any questions about "invisible" underwater asset managers will remain unanswered until the next liquidity crisis drags not only the MMF industry but everyone else down. Because despite what Yellen, Bernanke, Greenspan et al wish to tell us, a credit bubble is never fixed with another credit bubble: it merely delays the day of reckoning while making its severity that much worse.
So before the government had to step in, what were the immediate actions by sponsors to mitigate the inevitable disaster:
Even so, the NAV data do not reflect the full extent of losses that might have occurred without sponsor interventions. Some of the reported shadow NAVs were likely boosted by common forms of sponsor support, such as direct cash infusions and sales of securities to sponsors at above-market prices. Of course, the data also do not reflect portfolio losses that might have occurred in the absence of Treasury’s guarantee program and other government support for MMFs in 2008.
In the table below, line 1 shows that seventy-two MMFs reported shadow NAVs at least once from September 5 to October 17, 2008, indicating that their shadow NAVs dipped below $0.9975 at some point in this period. Although some funds reported data daily, all funds with shadow NAVs below $0.9975 were required to report at least weekly, and the number of reports jumped each Friday. Line 1 lists the number of funds reporting shadow NAVs on each Friday, which ranged from nineteen to sixty-three. Line 2 shows that on most Fridays the majority of reporting MMFs had shadow NAVs of $0.9975 or less.
Twenty-nine MMFs reported a shadow NAV below $0.995—low enough to break the buck, absent sponsor support—at some point during this episode (line 3). As many as eleven MMFs on any particular Friday reported shadow NAVs below 99.5 cents, including five funds that reported NAVs below this level before the Lehman Brothers bankruptcy. Average shadow NAVs for all reporting funds, excluding the effects of guarantees, dropped to $0.993 on October 3 and October 17 (line 4). Among funds with NAVs falling below $0.995 at some point, minimum shadow NAVs averaged $0.978 (line 5, column 1). That is, these funds lost, on average, at least 2.2 percent during the crisis.
In other words, money markets were insolvent on the days before the Lehman bankruptcy crashed the system, but they became really insolvent after.
The scale and scope of the losses in 2008 also highlight the significance of sponsor support for MMFs. After all, what made the Reserve Primary Fund unique in 2008 was neither its exposure to Lehman Brothers nor its portfolio losses, but the fact that its sponsor could not absorb its losses. However, the industry’s reliance on implicit recourse to sponsors is systemically risky because it creates channels for transmitting destabilizing strains between sponsors and their “off-balance-sheet” MMFs, and because uncertainty about whether sponsors will come to funds’ rescue may precipitate runs (McCabe 2010). Hence, the data we have described underscore the need for robust and effective MMF reforms that would provide a form of stability to the MMF industry not predicated on voluntary and uncertain support from sponsors.
But why is the Fed admitting that everything beneath the surface (of the Fed's liquidity tsunami) is rotten? Simple: this latest "expose" on Money Markets is merely the latest attempt to restructure the money market industry: a process that started long ago with the Group of 30, the SEC, and Federal Reserve. Why restructure? Because at last check, retail and institutional money markets held just under $2.5 trillion in assets, read cash. And with QE forced to end sooner or later, for the simple reason that the Fed is now monetizing 0.4% of all 10 year equivalent bonds per week (since there is no taper in a reduced deficit environment), what would the Fed want more than anything? Why a brand new wave of "asset rotations", one originating from the Money Market industry - so famously loathed by the status quo - and used to buy, what else, stocks. Preferably at their all time highs.