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.
Watching the paper markets freeze is a experience I won’t ever forget. There was a palpable sense that we might be watching the end of Western Capitalism.
If that seems dramatic you have to realize the inherent liquidity in money markets before Lehman imploded.
For the money markets to freeze would be as if you went to the store and tried to pay with your debit card and the store said “oh we do not accept checks or debit cards from Bank of America anymore, sorry”
Then in a panic you ran to the ATM and the ATM said “only half of funds available.” Enraged you checked it again, this time it says “only 1/3 of funds available”
You can’t spend your debit card and the ATM won’t give you your money back. If you are not in complete freak out mode right now then you are a utterly cool cat.
Now imagine that this is happening or is about to happen to everyone, with every bank, in every country in the world. You suspect that not all of them will be cool cats.
You spend a second wondering whether you should try to fix this as best you can or make your way quickly and quietly to Wal-Mart before they run out shotgun shells.
That’s what we were watching in the shadow banking system.