The Money Market Run

Something that’s been bugging me for a while now is that people largely seem to have forgotten what it is that actually happened in the fall of 2008 as the financial crisis reached its most acute stage. Amar Bhidé’s new book, A Call for Judgment: Sensible Finance for a Dynamic Economy, isn’t primarily a history of this episode but it does contain a handy one-paragraph summary of why it is that the powers that be didn’t just let things fall apart:

The common wisdom was that money market funds were “unrunnable,” because all withdrawals (redemptions) could be met by selling the assets of the fund. The illusion was shattered in September 2008. The pioneering Reserve Fund had large holdings of commercial paper issued by Lehman Brothers; the failure of Lehman triggered redemption requests for more than $20 billion on September 15, but less than half could be honored by selling assets since the markets were frozen. By the end of the next day, more than $40 billion of redemption requests were received. On the seventeenth, redemption requests were surging at all money market funds, but the funds were unable to sell any but their safest and shortest term securities. The commercial paper market froze and with it the capacity of issuers—both financial institutions and industrial companies—to raise the funds needed for day-to-day functioning.

It would be silly to say that the policies adopted in response to this—TARP and the AIG bailout, primarily—were the only possible responses. But absent some kind of (nominally) costly and unpopular bailout we would have had a costly and unpopular sequence in which people’s “safe” money market accounts were wiped out, to say nothing of perfectly solvent firms being suddenly unable to meet payroll.

And the problem here was quite abstract and general. We had all these accounts that households and firms were treating like super-safe unrunnable deposits when they were, in fact, vulnerable to runs. The specific incident was touched off by Lehman Brothers’ bankruptcy which, in turn, was driven by housing bubble issues but even had that whole episode been avoided the vulnerability was still lurking there.