The promised long version of “The Week America’s Economy Almost Died”, the sequel to The Giant [Global] Pool of Money, has shipped!
Okay, for those keeping track, this market freeze-up has been compared, so far in our story, to an oncoming train, an abyss, a monster, and an earthquake. All we need now is a serial killer.
And what made this abyss, earthquake, train, monster materialize all of sudden?
There was one event in particular that frightened the commercial paper market and made it seize up. Explaining it, I’d afraid, means using another finance term, although this one might be a little more familiar: the money market mutual fund.
And we should say here, a money market mutual fund is just, it’s like a savings account: there’s a good chance you even have one; it is, in normal times, it’s one of the safest places to keep your money. You put $1,000 bucks in; you know for sure you’ll get $1,000 bucks out — maybe even $1,010. And you’re happy with just that little return, because you know, at least your money is secure.
Now, one of the main things that money market managers do, to get that little return, is they lend money out on the commercial paper market. They give guys like Mark Peterson at ServiceMaster that $999,000; he gives them that $1,000,000 back the next day. It’s an OK return, but the main thing is: it’s safe, their money is safe, because they’re lending it to huge, trusted companies, many of which have been around for decades, reliably paying back these loans.
At least, that’s the way it was until two weeks ago, when one most dreaded things happened, at least in the world of money market managers — it’s the thing they have nightmares about.
One of the biggest, and oldest funds, called the Reserve Fund, that was its name, it broke the buck. What that means is, for the first time ever, it lost its depositors’ money. For every $1.00 they put in, they were left with only 97 cents…
It’s a big deal.
“Breaking the buck, is, is sort of like, uh, having a serial killer in high school; it caused a little bit of panic… People are not concerned with getting a return on capital; they just want the return of capital. So that, that is panic; that is fear.”
That panic and fear caused an old-fashioned bank run. People, and more importantly, pension funds and big endowments, called their brokers and said, “Get me out of those funds!” The government had to step in and guarantee the money market funds.
And this, right here, as near as we can tell, this is what freaked out Henry Paulson and Ben Bernanke. Because this, right here, is the mortgage crisis spreading out into the rest of the world.
This fund that broke the buck? They weren’t investing in risky mortgages or anything related to the mortgage industry; they were not free-wheeling Wall Street fat cats taking big risks and hoping for a windfall. They were investing in investments that those fat cats laughed at. These were fund managers doing everything possible to be Totally Safe, doing what they always did: buying very safe, very short-term commercial paper.
But it just so happened that the company they bought it from, was Lehman Brothers, and the day before, Lehman had gone bankrupt, in part, because of its exposure to risky mortgage products. So all the money this money market mutual fund, the Reserve Fund, had lent to Lehman was suddenly gone…
“That’s what caused the panic. All the other money market mutual fund managers freaked out. They wondered, who’s gonna be next? And then, like a horror movie, at least, a horror movie made for money market mutual fund managers, another fund broke the buck. And then AIG, the largest insurance company in the world, nearly collapsed.
That was it: money fund managers decided, we’re not lending out any more money out to companies at all.”
The scary monsters in the story: the lock-up of the commercial paper market (above), and the leverage in the credit default swap market. I swear to God I’m not kidding.
“That doesn’t sound scary…that sounds boring,” I hear you say.
“Well, allow me to retort:”
The amount of credit default swaps used for speculation grew to dwarf the amount that were actually used for insurance…
“The corporate bond market cash market is approximately $5 trillion, and the notional value of [credit default swaps] outstanding is approximately $60 trillion.”
In other words, there are $5 trillion of bonds in the world, but the total amount that people have bet on those bonds is $60 trillion. For every bond, there are 10 people promising to pay the full amount if the bond goes bad.
Oh, and there’s one more thing:
“All of this is unregulated, partly because they wanted it to be unregulated…”
“The idea that you can have $60 trillion in a financial market, which is more than all the stocks sold anywhere in the world, and not have any oversight whatever, is self-evidently absurd, and we’re seeing the end result of that today.”
Finally, the show details why an equity-injection plan would be (so!) much better than the big, stupid Paulson bailout plan.
Don’t wait! Get it via podcast from This American Life right now!
Or, download it directly from the This American Life website here.
Or, download it from iTunes here.
“#365: Another Frightening Show About the Economy”
October 3, 2008.
