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The next link in the panic chain came from money market mutual funds.

Many market commentators, including very sophisticated ones.

Over the weekend before Lehmann's bankruptcy believed,

it had been six months since Bear Stearns bankruptcy, or

Bear Stearns near bankruptcy and rescue by By JP Morgan.

The markets have had a lot of time to figure out how they would be able to

handle the bankruptcy of an institution like Lehman Brothers.

There was a certain amount of confidence, in some places bordering on hubris,

that we understood all of these deep, complex connections that

Lehman Brothers would have with the rest of financial markets.

One place that was missed, one very important connection that was missed

Was Lehman Brothers connection with money market mutual fund.

Money market mutual funds are a specific kind of investment company.

We discussed them as one important part of the shadow banking system in an earlier

lesson of this module.

They're only permitted to own a narrow range of securities.

So far more restrictive than what a bank can do with their deposits.

Money market mutual funds can only own short term highly rated securities.

And in return for accepting that narrow investment range in

their mandate from the SEC, which is their regulator.

They have the right at this time to report stable values for their share prices.

This is to say that if their portfolio was actually worth 99.8 cents on the dollar.

They were still allowed to report that it was worth 100 cents on the dollar, and

to tell their investors that their dollar was still worth a dollar.

On September 16, 2008, Reserve Primary Fund, a very large and

longstanding money market mutual fund And, broke the buck.

And they broke the buck meaning that their value of their portfolio fell below

what they were allowed to round up to 100 cents on the dollar.

Which in this case was 99.5 cents.

It fell below that.

They were no longer allowed to round up.

And the parent entity of this fund was unable to hand enough money over to

the fund so that it would actually be able to round up.

They then had to report a value for

their fund to their shareholders which was less than a dollar.

This is called breaking the buck.

This was due almost entirely to their exposure to Lehmann Brothers commercial

paper.

They had lent money to Lehman Brothers and

in the day following Lehman Brothers Failure.

The value of that commercial paper plummeted,

they're forced to mark that plummeting value to market on their report back to

shareholders of their net asset value and now they're no longer worth a dollar.

Now when people put their more money or

more importantly when institutions put their money in money market mutual funds.

They don't want to think about it.

These are the classic type of safe assets,

assets that are supposed to be information insensitive.

Not only am I giving you the money and expecting it to be safe But I have no

staff available to go and analyze whether or not my money actually is safe.

Just like when we give our money to the bank we're expecting,

in a deposit to get our money back.

People who give money and institutions who gives money in money market mutual

funds are expecting to get their money back.

The first thing that happened as soon as the reserve primary fund broke the book is

that there was a run.

And there was a run on all of the funds that were similar to reserve primary.

And it was a run predominantly driven at this time by institutional investors.

That run led quickly to panic on the part of all market commentators and

to regulators coming in with a guarantee,

on a whole lot of the long standing assets in money market mutual funds.

Now, we should've seen this coming.

And we should've seen this coming because in August of 2007 when we first had

runs on asset backed commercial paper,

which money market mutual funds are also large investors in.

Many money market mutual funds were in trouble and would have broken the buck

Unless they had received support from their parent entities.

So a large mutual fund complex,

if they see that one of their funds is falling below $1 a share is entitled to

transfer money in from their central coffers in order to shore up that fund.

They later reported that they did that exact thing.

That was reported in SEC filings.

But rather than make people nervous about money market mutual funds,

it seemed to reinforce people's belief that these really were very safe.

Since after all the parents will stand behind them.

This is purely private form of bailout, you could call it.

But if you think that a money market mutual fund is too big to fail within

a mutual fund complex, you're gonna feel very safe with your money in it.

Even if there is some kind of a hit.

In December of 2008, the hit was too large, and the institutions that

would've been able to support their funds earlier were unable to do so.

Thus, the run.

An important paper by Patrick McCabe of the Federal Reserve Showed

that during this initial stepping up of support in 2007,

during the run on asset-backed commercial paper.

The assets under management at money market mutual funds actually grew,

because people believed that these implicit promises of sponsors would really

help them.

The 43 money market mutual funds that were bailed out by their sponsors.

When that news came out,

helped rather than hindered the money market mutual fund industry.

In September 2008, this was not possible.

And we can see this in the following picture.

This is taken from McCabe's paper.

On the y-axis are assets

under management in money market mutual funds by investment objective.

There are three types of money market mutual funds.

Prime, which is the type that reserved primary was, and

the place where we have the majority of assets.

Prime funds are allowed to invest in any security that is

highly rated in short term.

They're not restricted to government securities or to tax exempt securities.

The other two categories on this list do have such restrictions

the blue dotted line are government only money market mutual funds and

the green line at the bottom are tax exempt money market mutual funds.

Now we can see this large rise going back to the late 1990's.

The total market was just over one trillion dollars for

assets under management.

By the time we reach the eve of the crisis in 2008,

if we add all of these different categories together.

We are up around four trillion dollars in assets for the money market mutual fund.

Compare that, for example, to the assets held overall in deposits by banks,

which was at this time approximately 10 trillion.

And you can see that money market mutual funds are a huge player.

They're really on the same order of magnitude that the entire banking system

is in terms of taking on and making promises about safe assets.

Now at the start of the asset backed commercial paper crisis in August of 2007,

that's the vertical line that you see right there in 2007.

We see that following that, there's an increase in the assets

to both the prime money market mutual funds, the black line.

And the government-only funds, the dotted blue line.

There's an influx into money market mutual funds at this time.

Why?

Well, many investors had previously kept their money

in asset-backed commercial paper.

When they no longer were putting in asset-backed commercial paper,

a very nice substitute for that Is money market mutual funds.

They went both to government funds, the blue dotted line,

and to the prime funds that had shown the ability to survive the asset-backed

commercial paper run, in many cases with support from their sponsors.

Now what happens however, when some of the money from asset-backed commercial paper,

some of it goes to prime funds.

But some of it now goes to the government funds.

Ultimately, government securities have been purchased and what has been sold

is the ultimate paper at the end of asset back commercial paper, which are things

that support student loans and credit cards and auto loans and mortgages.

So we have transferred some holdings to government away from that.

That's a bit of a strain on the real economy,

a strain that will continue to hold over the subsequent year.

In September 2008, at the Lehmann bankruptcy, which is the second

vertical line that you can see in this figure, we see the effects of the run.

Following September 15th, we have on the oder of $400 billion dollars,

falling away from prime money market mutual funds.

Almost all of it, flowing into government money market mutual funds.

The drop in the black line is

more than completely offset by the rise in the blue line.

Government securities at this point are a safe haven.

Everybody wants to own them, or

wants to own money market mutual funds that can buy them.

This drop off was only stopped

by a government guarantee that came within days of Lehman's failure.

In the absence of that, you can do your own extrapolation of this line and

where it would have gone.

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Lecture: MMMFs

The Global Financial Crisis

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