September 18, 2008: Day of near financial armageddon? (updated)
February 11, 2009
Yesterday morning, Brendan Loy posted on his Friend Feed a story that has floated around various on-line outlets that centers around Representative Paul Kanjorski’s account of the events of September 18, 2008. I seemed to remember reading about the day in question after the fact, but didn’t think much of it.
Today, Brendan linked to a Conde Nast Portfolio post questioning whether Kanjorski’s account is true. Brendan’s comment made me interested enough to look into this:
Not just a fair question, but a crucial one. I don’t understand why the mainstream media isn’t picking up on this and investigating it. It’s perhaps the most important news story of the week. If some congressman revealed that, five months ago, he was told that, unbeknownst to the public, we were 3 hours away from a nuclear bomb going off in a major American city, the MSM would cover that, right? This is essentially the economic equivalent of that. So where’s the coverage?
Kanjorski’s account was recorded on C-Span’s Washington Journal program on January 28. In response to a caller’s question turned rant on the TARP he said the following (22:45 into the video):
Look, I was there when the Secretary, and the uh Chariman of the Federal Reserve came those days to talk to members of Congress about what was going on. It was about September 15 (September 18, to be specific-Charles).
Here’s the facts and we don’t even talk about these things. On Thursday at about 11 o clock in the morning the Federal Reserve noticed a tremendous drawdown of uh money market accounts in the United States to the tune of 550 billion dollars was being drawn out in the matter of an hour or two. The Treasury opened up its window to help. They pumped 105 billion into the system and quickly realized they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation. Close down the money accounts and announce a guarantee of $250,000 per account so there wouldn’t be panic out there and that’s what actually happened.
If they had not down that their estimation was that by 2 o clock that afternoon 5 and a half trillion dollars would have been drawn out of the money market system of the United States, would have collapesed the entire economy and within 24 hours the world economy would have collapsed.
I shall attempt to smoothly cover the question raised by the CNP blogger and his commenters as well as review press coverage of the evening in question.
There is no doubt there were significant problems in money market accounts during that week (See Money Markets Funds Battered for an overview). On the 17th, Putnam Investments closed a $12.3 billion money market fund, citing “significant redemption pressure”. A citation inside an SEC rule states:
Between September 11th and September 17th, the assets of
institutional money market funds fell by $173 billion. See
Investment Company Institute, Money Market Mutual Fund Assets (Sept.
18, 2008), http://www.ici.org/stats/mf/mm_09_18_
Unfortunately, the original citation is unavailable. What is available from them is for the month as a whole:
Money market funds had an outflow of $145.16 billion in September, compared with an inflow of $28.43 billion in August. Funds offered primarily to institutions had an outflow of $148.87 billion. Funds offered primarily to individuals had an inflow of $3.70 billion.
Of course, those numbers are net; there’s no telling how much came out on the 18th before coming back in. In its story on Putnam, Forbes reported that $89.2 billion came out of money market funds on the 17th alone.
But, there is this account in the New York Post (emphasis added):
According to traders, who spoke on the condition of anonymity, money market funds were inundated with $500 billion in sell orders prior to the opening. The total money-market capitalization was roughly $4 trillion that morning.
The panicked selling was directly linked to the seizing up of the credit markets – including a $52 billion constriction in commercial paper – and the rumors of additional money market funds “breaking the buck,” or dropping below $1 net asset value.
The Fed’s dramatic $105 billion liquidity injection on Thursday (pre-market) was just enough to keep key institutional accounts from following through on the sell orders and starting a stampede of cash that could have brought large tracts of the US economy to a halt.
CNN did report 105 billion being put in by the Federal Reserve:
The Federal Reserve this morning, in three separate operations, has injected $105 billion into the financial system, into the banking system. This is a record amount in one day, even greater than the $81 billion that the Fed injected following September 11 after the attacks. So this — this is really a big move by our central bank to try to keep the wheels of finance turning.
I couldn’t find anything to support interpretations of the statement “They decided to close the operation”. My interepretation was “The Fed decided to stop putting out money, because it wasn’t going to be enough to help” (in contrast to the CNP’s blogger’s interpretation that he was claiming funds themselves were being closed or withdrawals from the Fed were suspended). One could read the New York Post account as suggesting that the Fed opted to stop pumping out money and instead leak news of the TARP.
A commenter questioned the $250, 00 guarantee. I believe the reference was to the Guaranty program introduced by the Fed the next day. Otherwise, he’s badly confused FDIC insurance, which didn’t go up until early October.
Now, what we’ve looked over is the Congressman’s account of what was said in that meeting. My search into this started with the article I thought I remembered reading about that day. It was contained in a New York Times article The Reckoning:
Two hours later, Mr. Paulson and Mr. Bernanke trooped up to Capitol Hill for a somber session with Congressional leaders. “That meeting was one of the most astounding experiences I’ve had in my 34 years in politics,” Senator Schumer recalled…
…As the members of Congress and their aides listened, the two laid out their plan. They would begin offering federal insurance to money market funds immediately, in order to stop the run on money funds…
From a more contemporaneous NYT account of the meeting”
As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”
Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”
When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”
“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.”
Although Mr. Schumer, Mr. Dodd and other participants declined to repeat precisely what they were told by Mr. Bernanke and Mr. Paulson, they said the two men described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day.
Most amusing was the account of the post-meeting press conference offered on MSNBC’s Countdown (emphasis added):
The meeting is over in Washington and so to the news conference. Leaders of the House, the Senate, the Fed, the SEC, the Treasury Department meeting at the Capitol. This on proposals to have the government buy up the so-called illiquid assets, in other words, endangered mortgages, mortgages no company wants to be responsible for. The head of the Fed, Mr. Bernanke, said it was a productive meeting, but there was actually nothing coming out of the session. Speaker Pelosi said she and the other Democrats and the bipartisan leaders who were present at the event are hoping for a proposal from the White House in hours and not days. And that was about it. You didn’t miss anything.
The interesting thing I noted when reading the various accounts of the meeting is that no one said anything specific beyond the level of being told “Financial doom impending, film at 11” (see LA Times’ Suddenly those bailout buckets looked too small for another example). The lack of commentary/speculation in media channels on what was said is curious, in retrospect. It was fun to find someone, a professor of finance at Northwestern, asking “What do they know that we don’t know?”:
All along I’ve been wondering what was said to Congressional leaders. Exactly what were they told and why haven’t we been told? It’s hard to assess the plan if you don’t know what’s wrong. I think there’s a good reason for the secrecy…
… then it’s obvious why Bernanke and Paulson could not explain everything. We still have to be afraid of widespread runs on financial institutions. Bernanke and Paulson wouldn’t announce that the financial system is insolvent for fear of inciting just such a run. Despite deposit insurance, we still have to fear bank runs (the Flow of Funds Account published by the Fed shows $2.4 trillion in time deposits exceeding $100,000 as of June — this is almost 30% of deposits). There was a run on money market funds earlier this month, stemmed by Paulson’s pledge of $50 billion in insurance. However, there are $3.3 trillion in assets in money market funds, so $50 billion of insurance could be used up in a flash. Widespread runs would be a disaster.
Indeed, it appears the Professor was on to something.
So, why doesn’t the media look further into this? Are they taking to heart the Representative’s words ” we don’t even talk about these things”? It’s fairly disappointing that a publication of the Economist’s repute tosses this story out there with I’M NOT even sure this makes sense, but it sure is dramatic! and little further comment. While the specific issue of the money markets may be too esoteric for most reporters, it certainly should be within the grasp of the Economist or someone at one of the business networks. (Elizabeth McDonald, for some reason, comes specifically to mind).
LATER: Felix Salmon’s (the CNP Blogger) follow-up tries to put the story down, suggesting that this is Kanjorski’s story alone, backed only by the anonymous quotes in the New York Post article. However, note this in the Joint Economic Committee report Financial Meltdown and Policy Response
On Thursday September 18, 2008, institutional money managers sought to redeem another $500 billion, but Secretary Paulson intervened directly with these managers to dissuade them from demanding redemptions. Nevertheless, investors still redeemed another $105 billion. If the federal government were not to act decisively to check this incipient panic, the results for the entire U.S. economy would be disastrous.
Kanjorski was/is not a member of that committee. If his account is mistaken, he’s not the only Congressman out there with bad information.