break the buck

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pages: 479 words: 113,510

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America by Danielle Dimartino Booth

Affordable Care Act / Obamacare, asset-backed security, bank run, barriers to entry, Basel III, Bernie Sanders, break the buck, Bretton Woods, central bank independence, collateralized debt obligation, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, greed is good, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, liquidity trap, London Whale, Long Term Capital Management, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, negative equity, new economy, Northern Rock, obamacare, price stability, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

Paulson informed Willumstad: Paletta and Scism, “Geithner Testifies in AIG Bailout Suit.” CHAPTER 13: BREAKING THE BUCK Will capitalist economies: Rich Miller, “Yalies Yellen-Hamada Put Tobin Twist Theory to Work in QE,” Bloomberg.com, October 21, 2013, www.bloomberg.com/news/articles/2013-10-31/yalies-yellen-hamada-putting-tobin-s-twist-theory-to-work-in-qe. The chairman of the Reserve Management Company: James B. Stewart, “Eight Days,” New Yorker, September 21, 2009, www.newyorker.com/magazine/2009/09/21/eight-days. By the time the senior Bent: Ibid. No other MMF had: Diya Gullapalli, Shefali Anand, and Daisy Maxey, “Money Fund, Hurt by Debt Tied to Lehman, Breaks the Buck,” Wall Street Journal, September 17, 2008. The news was “really, really bad”: Ibid. “Paulson and Bernanke totally”: Stewart, “Eight Days.”

CONTENTS TITLE PAGE COPYRIGHT DEDICATION CHAPTER 1: “Groupstink” CHAPTER 2: Who Would Buy That Crap? CHAPTER 3: Saint Greenspan CHAPTER 4: Inside the Black Box CHAPTER 5: The First Tremors CHAPTER 6: Front-running the Fed CHAPTER 7: The Maverick CHAPTER 8: The Inner Sanctum CHAPTER 9: “Luddite!” CHAPTER 10: Helpless CHAPTER 11: Slapped in the Face by the Invisible Hand CHAPTER 12: Heads Must Roll CHAPTER 13: Breaking the Buck CHAPTER 14: Breaching the Zero Bound CHAPTER 15: The Walking Dead CHAPTER 16: Dr. Ben Pulls a Bait and Switch CHAPTER 17: A Turning Point CHAPTER 18: Insider Trading? CHAPTER 19: Spinning Fedwire CHAPTER 20: The Taper Tantrum CHAPTER 21: The New Sheriff in Town CHAPTER 22: Culture Shock ACKNOWLEDGMENTS NOTES INDEX CHAPTER 1 “Groupstink” Never in the field of monetary policy was so much gained by so few at the expense of so many.

I felt I had aged a decade over the last twelve months.) Eventually the bailout would total $184.6 billion, with the Fed taking a 92 percent government stake. Paulson informed Willumstad that he had to go. Another head rolled down Wall Street, coming to rest alongside that of Dick Fuld. Bernanke and crew didn’t have even a moment to catch their breath when Lehman’s collapse ricocheted and blindsided them again. CHAPTER 13 Breaking the Buck FED STATEMENT WORD COUNT: 420 EFFECTIVE FED FUNDS RATE: 0.08% 10-YR TREASURY RATE: 1.97% FED BANKS TOTAL ASSETS: $2,919.55B DATE: 1/1/2012 Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not. Do policymakers have the knowledge and ability to improve macroeconomic outcomes rather than make matters worse? Yes. —JANET YELLEN, APRIL 1999 When Bruce R.


pages: 350 words: 109,220

In FED We Trust: Ben Bernanke's War on the Great Panic by David Wessel

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Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, Black Swan, break the buck, central bank independence, credit crunch, Credit Default Swap, crony capitalism, debt deflation, Fall of the Berlin Wall, financial innovation, financial intermediation, fixed income, full employment, George Akerlof, housing crisis, inflation targeting, information asymmetry, London Interbank Offered Rate, Long Term Capital Management, market bubble, money market fund, moral hazard, mortgage debt, new economy, Northern Rock, price stability, quantitative easing, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, savings glut, Socratic dialogue, too big to fail

“Our sense and our intelligence was, there was no hope of getting something like this, given the very short legislative schedule, given the complexity of such a thing, given the lack of appetite for such a thing. So we didn’t make a serious attempt to get Congress to pass anything,” he explained. But then, second-guessing himself for a moment, he added, “If we had, we wouldn’t have gotten it … but at least we would have been able to say we tried.” BREAKING THE BUCK The turmoil in the financial markets during the week of September 15 didn’t revolve only around newfangled financial instruments, cross-border sophisticated bets, or the collapse of major financial institutions. In fact, the biggest surprise of Lehman’s collapse came from money market funds, the $1-a-share mutual funds that Americans had come to consider as safe as bank accounts. Money market funds had been on the Fed list of things to worry about for months, dating back to the fragility of the tri-party repo market and the Bear Stearns episode.

A couple of Fed staffers called back an hour or so later, listened, and said they would pass the request along. “The Fed officials cautioned the participants on the call not to be overly optimistic,” the minutes of the Reserve Fund’s board record drily. Around 3:45, the Fed said, “No.” At 4:15 P.M., the fund issued a press release. The Lehman paper in its portfolio was worthless and the Fund’s shares were worth not $1, but only 97 cents: breaking the buck. The news triggered a run that spread through the $3.4 trillion industry. (Bruce Bent II and his father, Bruce Bent Sr., were later accused of fraud by the SEC, which said they had misled investors, credit rating agencies, and the money market fund’s trustees in failing to disclose “key material facts” about the fund’s vulnerability when Lehman collapsed, among other transgressions. The elder Bent said in a statement that he remained “confident that we acted in the best interest of our shareholders.”)

Scores of brand-name industrial companies — General Electric, Caterpillar, Dow Chemical — relied on the money market funds for their short-term borrowing, often issuing the funds IOUs called commercial paper that were backed only by the companies’ promise to pay. The Fed and the Treasury decided that to avoid a stampede out of money market funds, they had to find a way to assure consumers that the Reserve Primary Fund wouldn’t be followed by scores of other money market funds breaking the buck. At the Fed, Don Kohn took charge of the response while Bernanke went to Capitol Hill and Warsh to New York. At the Treasury, the job fell to David Nason, the assistant secretary for financial institutions. Nason recently had recused himself to look for a job. After AIG imploded, he dropped the job hunt and returned to work. In the frantic search for a solution, talk bubbled up about the Fed lending directly to the money market funds.


pages: 309 words: 95,495

Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe by Greg Ip

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Affordable Care Act / Obamacare, Air France Flight 447, air freight, airport security, Asian financial crisis, asset-backed security, bank run, banking crisis, break the buck, Bretton Woods, capital controls, central bank independence, cloud computing, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, Daniel Kahneman / Amos Tversky, diversified portfolio, double helix, endowment effect, Exxon Valdez, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, global supply chain, hindsight bias, Hyman Minsky, Joseph Schumpeter, Kenneth Rogoff, London Whale, Long Term Capital Management, market bubble, money market fund, moral hazard, Myron Scholes, Network effects, new economy, offshore financial centre, paradox of thrift, pets.com, Ponzi scheme, quantitative easing, Ralph Nader, Richard Thaler, risk tolerance, Ronald Reagan, savings glut, technology bubble, The Great Moderation, too big to fail, transaction costs, union organizing, Unsafe at Any Speed, value at risk, William Langewiesche, zero-sum game

But by the end of Tuesday, with Lehman debt now priced at zero cents on the dollar, they concluded they could not, and announced that Reserve’s shares were now priced at 97 cents instead of one dollar. Federal Reserve and Treasury officials had spent the weekend trying to imagine and prepare for every collateral effect of a Lehman bankruptcy. One thing they apparently did not consider was that a money market fund might break the buck. That announcement arguably sowed as much panic as Lehman’s bankruptcy itself. Within a week, investors yanked a total of $349 billion from almost every money market fund not invested solely in Treasury bills, regardless of whether it had exposure to Lehman. Some thirty-six of the one hundred largest U.S. prime money market funds were eventually supported. Meanwhile, the funds themselves stopped buying commercial paper, the short-term IOUs that everyone from General Electric to obscure investment funds had come to rely on to fund everything from equipment inventory to subprime mortgage-backed securities.

Lehman’s paper retained its top rating from Moody’s and Standard & Poor’s until the day of its bankruptcy; the Securities and Exchange Commission had overseen Lehman through a special oversight program, with staffers on site; and the SEC’s chairman had pronounced Lehman’s capital sufficient. But many other investors had been skeptical of such assertions and avoided Lehman paper; arguably, Bent should have done the same. Still, there were at least two other assumptions grounded in decades of experience that suggest why Lehman’s failure and Reserve’s breaking the buck came as such shocks. The first was that Lehman would not be allowed to fail. Indeed, in the prior four decades, no financial firm even close to Lehman’s size or importance had been allowed to collapse. As we saw in Chapter 2, when the collapse of a big bank threatened the economy, Volcker worked hard to prevent it, lending to Mexico and leading the bailout of Continental Illinois. In the years thereafter, regulators had intervened to protect the uninsured depositors of the fourteenth, thirty-third, and thirty-sixth largest banks.

Rate of return was much less important than safety and immediate access to funds. “We could get our cash any day that we would need it,” explained one investor in Reserve. “And it gave us safety because the money market fund was a dollar in, you get your dollar out.” Of course, these investments weren’t bank deposits. Funds were not legally obligated to maintain the dollar per share value. But in practice, the reputational damage of breaking the buck was so great that sponsors—the management companies who ran the funds—almost always put their own capital in rather than allow it to happen. It later emerged that, between 1972 and the lead-up to the crisis, there had been 146 instances of a fund sponsor intervening to preserve the dollar per share value of a money market fund. As I mentioned earlier, only once had a fund actually broken the buck and been forced to liquidate.


pages: 113 words: 37,885

Why Wall Street Matters by William D. Cohan

Apple II, asset-backed security, bank run, Bernie Sanders, bonus culture, break the buck, buttonwood tree, corporate governance, corporate raider, creative destruction, Credit Default Swap, Donald Trump, Exxon Valdez, financial innovation, financial repression, Fractional reserve banking, Gordon Gekko, greed is good, income inequality, Joseph Schumpeter, London Interbank Offered Rate, margin call, money market fund, moral hazard, Potemkin village, quantitative easing, secular stagnation, Snapchat, South Sea Bubble, Steve Jobs, Steve Wozniak, too big to fail, WikiLeaks

The problem, as usual, is not the honorable goal of trying to prevent a money-market fund from ever again breaking the buck; the problem is the unintended consequences of trying to make sure that doesn’t happen. Once upon a time, Alan Greenspan, another former Federal Reserve Board chairman, spoke about the Fed’s being an organization that set monetary policy with a minor regulatory function attached to it. Today, the Fed’s monetary function is the minor appendage to its growing regulatory juggernaut. One man, Daniel Tarullo, has become the embodiment of the Fed’s new focus; in the process, he has become the most feared and powerful Washington banking regulator. He is also unknown to the American people. (That needs to change; a bright light needs to be focused on him and his reforms.) Tarullo is the driving force at the Fed seeking to make sure things like “breaking the buck” never happen again.


pages: 593 words: 189,857

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

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Affordable Care Act / Obamacare, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bernie Madoff, Bernie Sanders, break the buck, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, David Brooks, Doomsday Book, eurozone crisis, financial innovation, Flash crash, Goldman Sachs: Vampire Squid, housing crisis, Hyman Minsky, illegal immigration, implied volatility, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, Nate Silver, negative equity, Northern Rock, obamacare, paradox of thrift, pets.com, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, RAND corporation, regulatory arbitrage, reserve currency, Saturday Night Live, savings glut, selection bias, short selling, sovereign wealth fund, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

The Lehman paper made up only about 1 percent of the $62 billion fund, but since the fund had no capital buffers to absorb losses, that was enough to create the stench of death; by that evening, the flood of requests for redemptions amounted to nearly two-thirds of the fund. The Reserve Fund asked the New York Fed for help to avoid breaking the buck, but my team said no. We didn’t think we could stop the run, and agreeing to their request would have amounted to an implied backstop for the entire $3.5 trillion money market industry. The Fed didn’t have the legal authority to guarantee money market funds and protect their investors from losses. “Ridiculous request,” Don Kohn agreed in an email. Still, the break-the-buck incident had cast suspicion on all prime money market funds. Institutional investors would withdraw more than $300 billion over the next week. The Reserve Fund debacle discouraged risk taking by other money funds, which meant even less buying of commercial paper and less lending through repo, which meant an even more intense liquidity crisis for banks and other institutions.

There seemed to be so many other greater dangers, like the investment banks. But money market funds had provided much of the financing for those other sources of systemic risk. Now we saw that these funds could be a threat. On an FOMC videoconference the evening after the Countrywide drama, the new head of my markets division, Bill Dudley, warned that mortgage-related losses “could conceivably cause some funds to ‘break the buck,’ ” meaning they wouldn’t be able to redeem deposits at the fixed one-dollar-per-share value their investors took for granted. “In the worst case, this could even result in a run from these funds,” Dudley said. Even in those early days of the crisis, the financial system looked much more vulnerable to runs than we had appreciated. Markets were fleeing to safety, looking for cash or cash-like instruments with minimal credit risk, shunning illiquid securities tainted by links to mortgages in general and subprime mortgages in particular.

British regulators had frozen some of Lehman’s client accounts, so overseas hedge funds were scrambling to retrieve their funds from Goldman Sachs and Morgan Stanley to avoid similar fates, even though both firms had reported decent earnings that day. Meanwhile, U.S. depositors were withdrawing about $2 billion a day from WaMu, twice as much as they had withdrawn after the run on IndyMac. The “TED spread,” a measuring stick for fear in the banking system, was about to surpass the record set after the 1987 stock market crash. Tuesday’s most chilling development outside AIG was a money market fund “breaking the buck,” which meant it could no longer promise investors 100 cents on the dollar. Money market funds were widely viewed as virtually indistinguishable from insured bank deposits, as similarly safe vehicles for storing cash with slightly better interest rates. But many money market funds had invested in commercial paper and other instruments that turned out to be riskier than they had thought. One fund, the Reserve Primary Fund, had even added to its stash of Lehman paper over the summer while everyone else was unloading it, which sparked a run on the fund after Lehman fell.


pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, banks create money, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial innovation, fixed income, friendly fire, full employment, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, market clearing, market fundamentalism, McMansion, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, price mechanism, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, working-age population, yield curve, Yogi Berra

(Remember the moral hazard: The government had engineered a rescue of Bear Stearns just six months earlier, leaving all the creditors whole.) That turned out to be a fatal miscalculation. Within just two days after Lehman declared bankruptcy, the Reserve was flooded with redemption requests amounting to about half the fund’s balances. After the close of business on Tuesday, September 16, management announced that its holdings of Lehman paper were worthless and that it was therefore forced to “break the buck”; that is, to redeem shares at less than their $1 face value. After a number of investors got out at par, and after other CP prices fell in the panicky environment, the remaining shares of the Reserve Primary Fund were worth only $0.97. A 3 percent loss doesn’t sound like much compared with everything else that was happening at the time. But, in fact, it was one of the signal events of the Panic of 2008.

The share price of a money fund never varied; it was always exactly $1, which removed any risk of capital gains or losses. This neat trick was accomplished originally by investing the funds’ assets in money-market instruments that hardly ever fluctuated in value, such as short-term U.S. Treasury bills. As time went by, and no retail money fund ever suffered losses large enough to force it to “break the buck,” commercial paper and other short-term instruments came to be viewed as safe enough to be included in money funds’ portfolios. And since CP paid a bit more than Treasury bills, that boosted the funds’ yields. Investors, for their part, came to consider money fund balances just as safe as bank accounts, even though the former carried no FDIC guarantees. The industry flourished, and by September 2008 money funds had $3.4 trillion in outstanding balances.

See also Morgan Stanley Maiden Lane, 107n Making Home Affordable, 334–37 Marketable debt, federal guarantee for, 161–62 Mayer, Chris, 326 Medicare/Medicaid, and federal budget deficit, 390, 398 Mellon, Andrew, 353 Meltzer, Allan, 349 Merrill Lynch Bank of America purchase of, 122, 129, 150, 152–53, 164–65 collateralized debt obligations (CDOs), 151–52 financial decline of, 151–52 leverage ratio of, 52 mortgage-related holdings, 89 Orange County derivatives failure, 60 post-collapse status, 52, 153 TARP funds for, 201 Mezzanine tranche, 74 Minsky, Hyman, 64, 434 Minsky moment, 64 Mishkin, Frederic “Rick,” 92, 105 Monetary policy recession, fighting with, 350 special tactics. See Unconventional monetary policy (UMP) Money market funds break the buck redemptions, 143–44 features of, 143–44 guarantees from Treasury, 145–47 no FDIC guarantees, 144 runs from (2008), 142–49 Monti, Mario, 424–25, 428 Moody’s, 400 rating failures, 79–81 Moral hazard and bailouts, 113–14, 125, 138–39 and European Central Bank (ECB), 423 meaning, financial scenario for, 108–9 past, learning from, 431–32 Washington Mutual lesson, 156–57 Morgan Stanley as bank holding company, 129, 154 as derivatives dealer, 61 financial decline of, 153–54 hedge fund run, 153 leverage ratio of, 52 PDCF loan to, 153–54 post-collapse reorganization, 52 TARP funds for, 201 Morgenson, Gretchen, 117 Mortgage-backed securities (MBS).


pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

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asset-backed security, bank run, banking crisis, Basel III, Black Swan, Black-Scholes formula, bonus culture, break the buck, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, diversification, Edmond Halley, facts on the ground, financial innovation, fixed income, George Akerlof, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, John Meriwether, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, money market fund, Myron Scholes, Nick Leeson, Northern Rock, offshore financial centre, Paul Samuelson, price mechanism, regulatory arbitrage, rent-seeking, Richard Thaler, risk tolerance, risk/return, Ronald Reagan, shareholder value, short selling, statistical model, The Chicago School, Thomas Bayes, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve, zero-sum game

Looking at this upstart market, the traditional lending banks could argue that if their depositors took those green spectacles off, Uncle Sam would be there to protect them in the form of the FDIC’s guarantee, which stood at $100,000 per customer in 2007. Money market funds responded that they didn’t need this protection because they weren’t “borrowing short and lending long,” as banks did—IOUs and repos were only short-term investments, not long-term loans. That distinction let them build up the confidence of their customers with a myth worthy of the Wizard of Oz: “We never break the buck.” In other words, for every dollar you invest with us, you will get at least a dollar back. This was an astounding claim, in part because the contractual small print on mutual funds made it clear that the redemption value of funds depended on the price that its assets could be sold for in the market: there was no guarantee your cash would be returned. Yet mutual funds succeeded in fostering a perception that investors were guaranteed to not lose money.

As Geithner’s lieutenants predicted, the industry coped with it, conducting a “credit event auction” and ensuring that default swaps linked to Lehman paid out smoothly, while Britain’s Barclays Bank grabbed Lehman’s U.S. brokerage business at a lucrative discount. It was only if you jumped off planet Derivative and back onto planet Earth that you saw the chaos and devastation caused by Lehman’s collapse. On planet Earth, getting eight and a half cents on the dollar was a disaster for investors across the world. On planet Earth was the Reserve Primary Fund, whose holding of Lehman IOUs caused it to “break the buck,” triggering a run on money market mutual funds. Clearly, the New York Fed’s view of what was an efficient free market was too narrow. In fact, it took only twenty-four hours for this regulatory confidence to evaporate. The trouble had been brewing a week before Lehman’s bankruptcy—New York Fed officials had learned that Moody’s and Standard & Poor’s were about to downgrade AIG to a single-A rating, which would trigger a payment of $13 billion of additional default swap collateral.

Treasury new powers to take over mortgage agencies Lehman Brothers tries to raise capital from Korea Development Bank, but talks go nowhere (September 8) Fannie Mae and Freddie Mac placed into conservatorship by Treasury (September 12) Counterparties lose confidence in Lehman, prompting a weekend of attempted deal making at the New York Fed Credit ratings agencies warn of imminent downgrade of AIG; New York Fed holds discussions concurrent with Lehman talks (September 14) U.K. government declines to facilitate takeover of Lehman by Barclays; Bank of America takes over Merrill Lynch (September 15) Lehman files for bankruptcy (September 16) New York Fed provides an emergency $85 billion loan facility to save AIG from bankruptcy triggered by collateral calls, and appoints a new CEO at AIG Reserve Primary Fund, invested in Lehman, “breaks the buck,” forcing the Fed to support money market funds (September 24) Goldman Sachs and Morgan Stanley receive new equity investments and become bank holding companies, formalizing their “too big to fail” status FDIC seizes Washington Mutual (September 29) Congress fails to pass TARP, and the Dow falls 770 points (October 3) Revised TARP bill passes Congress (October 6) Wells Fargo acquires Wachovia Germany, Belgium, and The Netherlands announce bailouts for problem banks (October 8) Federal Reserve and international central banks impose coordinated emergency interest rate cuts (October 10) OIS-Libor spread peaks at 364 basis points: interbank lending has broken down (October 12) Royal Bank of Scotland receives emergency bailout from U.K. government, and CEO Sir Fred Goodwin is ousted (October 14) U.S. government announces injection of $250 billion of TARP capital into U.S. banks New York Fed creates two special companies to buy AIGFP-related CDOs and securities lending-related mortgage bonds, paying counterparties such as Goldman 100 percent of market value (October 3) Avoiding the need for U.K. government funds, Barclays raises £7 billion of capital from Middle Eastern investors (November) President Obama elected; Geithner tapped as Treasury Secretary HSH Nordbank receives German government bailout (December) Irish government bails out banks Citigroup receives an additional $20 billion TARP bailout and $300 billion of debt guarantees from the U.S. government 2009 (January) U.K. government announces additional bailout of Royal Bank of Scotland and other banks President Obama inaugurated (April) Case-Shiller house price index reaches a trough 2010 (May) Greece is frozen out of bond markets, leading to an EU and IMF bailout (July) Goldman pays $550 million to settle SEC lawsuit over Abacus 2007 AC-1 Dodd-Frank bill signed into law (September) Basel III banking rules finalized (October) “Robo-signing” foreclosure scandal leads to wave of lawsuits against banks (November) Market confidence in Ireland evaporates, leading to an IMF/EU bailout in December Notes Chapter One 1.


pages: 430 words: 109,064

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

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Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, break the buck, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Gordon Gekko, greed is good, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

.* On Tuesday, with the collateral damage caused by Lehman’s failure beginning to spread, the Fed stepped in with an $85 billion credit line to keep AIG afloat, fearing that if the insurer defaulted on its hundreds of billions of dollars in credit default swaps, its counterparties would suffer devastating losses—or, at the least, fear of those losses would cause the financial markets to grind to a halt. Also on Tuesday, the Reserve Primary Fund, one of the largest money market funds, announced that it would “break the buck”; because of losses on Lehman debt, it could not return one dollar for each dollar put in by investors. As a result, money flooded out of money market funds, forcing Treasury to create a new program to provide insurance for those funds. The flight from money market funds dried up demand for the commercial paper used by corporations to manage their cash, raising the specter that major corporations might not be able to make payroll.

Certain financial institutions are so big, or so interconnected, or otherwise so important to the financial system that they cannot be allowed to go into an uncontrolled bankruptcy; defaulting on their obligations will create significant losses for other financial institutions, at a minimum sowing chaos in the markets and potentially triggering a domino effect that causes the entire system to come crashing down. The bankruptcy of Lehman Brothers in September 2008 accelerated the collapse of American International Group, forcing it into the arms of the Federal Reserve; Lehman’s failure also forced the Reserve Primary Fund to “break the buck,” causing a sudden loss of confidence in all money market funds; in turn the flood of money out of money market funds caused the commercial paper market to freeze, endangering the ability of many corporations to operate on a day-to-day basis. The failure of Lehman also caused large cash outflows from the remaining stand-alone investment banks, Goldman Sachs and Morgan Stanley. The sequence of falling dominoes was only stopped by massive government rescue measures, and the panic that occurred despite the government’s intervention helped transform a mild recession into the most severe recession of the postwar period.


pages: 468 words: 145,998

On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by Henry M. Paulson

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asset-backed security, bank run, banking crisis, break the buck, Bretton Woods, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Doha Development Round, fear of failure, financial innovation, fixed income, housing crisis, income inequality, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, Northern Rock, price discovery process, price mechanism, regulatory arbitrage, Ronald Reagan, Saturday Night Live, short selling, sovereign wealth fund, technology bubble, too big to fail, trade liberalization, young professional

., Bill Osborn, the chairman of Northern Trust and a good friend from Chicago, called with a firsthand report. “I hate to bother you, Hank,” he said. “But there is no liquidity in the markets. The commercial paper market is frozen.” Bill proceeded to tell me about problems he was having with his money market funds. Because the market for commercial paper had seized up, the funds were under real pressure from withdrawals, and he was looking for ways to avoid breaking the buck. He was working on a way the parent company could support the funds financially without taking the obligation on its balance sheet. But this solution required accounting relief. He’d already called the SEC but wanted to let me know of the looming problem. I told Bill that I was focused on AIG, but that the Fed was working on a number of liquidity programs to get people to start buying paper again.

These funds invest for the most part in commercial paper instruments with a top credit rating or in government or quasi-government securities. Before the crisis, investors had come to believe that they would always have liquidity and would be able to get 100 percent of their principal back, because funds would always maintain a net asset value (NAV) of at least $1.00. In the immediate aftermath of the Lehman failure, money market mutual funds came under intense pressure. A number were on the verge of “breaking the buck.” This dramatically eroded investor confidence, causing redemption requests to soar. In turn, the money funds pulled back on their funding of the many large financial institutions that depended on them for a big portion of their liquidity needs. It was a development that we were not well equipped to address. We stepped in to guarantee the money market funds to prevent the crisis from getting worse, but the fundamental problems in the industry’s business model remain.


pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

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air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, break the buck, Bretton Woods, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy, zero-sum game

See Blinder, After the Music Stopped, p. 123. 16. Paulson, On the Brink, p. 220. See also Evelyn Rusli, ‘The Universal Appeal of BofA’, Forbes.com, 15 September 2008, http://archive.is/w503. 17. Blinder, After the Music Stopped, pp. 229–31, and ‘Fed in $85bn AIG Rescue Deal’, Financial Times, 17 September 2008. 18. Paulson, On the Brink, p. 230. 19. Paul Davies and Michael Mackenzie, ‘Money Fund Sector Shocked as Reserve Breaks the Buck’, Financial Times, 18 September 2012. 20. On the administration in the UK, see http://www.pwc.co.uk/business-recovery/administrations/lehman/lehman-faq.jhtml. 21. House of Commons Treasury Committee, ‘Evidence on 24th June 2009’, Banking Crisis: Regulation and Supervision, 14th Report of Session 2008–09 (London: The Stationery Office, 31 July 2009), Ev32. 22. Ibid., p. 230. 23. Francesco Guerrera, Henny Sender, Michael Mackenzie, Krishna Guha, James Politi and Daniel Dombey, ‘Fears Emerge over $700bn Rescue’, Financial Times, 22 September 2008. 24.

Back from the Brink: 1,000 Days at Number 11 (London: Atlantic Books, 2011). Darvas, Zsolt. ‘Intra-Euro Rebalancing is Inevitable, but Insufficient’, Bruegel Policy Contribution Issue 2012/15, August 2012. www.bruegel.org. Darvas, Zsolt. ‘The Euro Area’s Tightrope Walk: Debt and Competitiveness in Italy and Spain’, Bruegel Policy Contribution Issue 2013/11,September 2013. www.bruegel.org. Davies, Paul and Michael Mackenzie. ‘Money Fund Sector Shocked as Reserve Breaks the Buck’, Financial Times, 18 September 2012. www.ft.com. Davis, Ian. ‘The New Normal’, McKinsey Quarterly (March 2009). http://www.mckinsey.com/insights/strategy/the_new_normal. Davis, Polk. ‘Basel III Leverage Ratio: U. S. Proposes American Add-On; Basel Committee Proposes Important Denominator Changes’, 13 July 2013. http://www.davispolk.com/sites/default/files/files/Publication/7a0a4791-d6cb-4248-8ff0–3f8968a19dab/Preview/PublicationAttachment/55dacc73-e480-42a3-9524-425fb2ffca3a/07.19.13.Basel.3.Leverage.pdf.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

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Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, Mark Zuckerberg, McMansion, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

Putting money into highly rated “collateralized-debt obligations” (CDOs), which bundle up the lower tranches of existing securitizations, was an opaque bet that America would not suffer a national housing-market meltdown. Similarly, putting your money into a bank account is a decision that is informed by an explicit system of deposit insurance: you will get your money back because the government guarantees it. For many, investing in a money-market fund is also a bet on a promise, but this time by a private actor not to “break the buck”—in other words, to give a dollar back for each dollar invested. These new products may look like the old ones, in other words, but there are differences that investors do not fully appreciate. As a result, when those underappreciated risks do surface, they come as a shock to market participants and prompt panic. Finance can survive many things, but panic is not one of them. The industry has been made more fragile by creating what Gennaioli, Shleifer, and Vishny term false substitutes—securities that investors believe to be riskless that turn out to be risky.


pages: 249 words: 66,383

House of Debt: How They (And You) Caused the Great Recession, and How We Can Prevent It From Happening Again by Atif Mian, Amir Sufi

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Andrei Shleifer, asset-backed security, balance sheet recession, bank run, banking crisis, Ben Bernanke: helicopter money, break the buck, Carmen Reinhart, collapse of Lehman Brothers, creative destruction, debt deflation, Edward Glaeser, en.wikipedia.org, financial innovation, full employment, high net worth, Home mortgage interest deduction, housing crisis, Joseph Schumpeter, Kenneth Rogoff, liquidity trap, Long Term Capital Management, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, quantitative easing, Robert Shiller, Robert Shiller, school choice, shareholder value, the payments system, the scientific method, tulip mania, young professional, zero-sum game

The answer is closely related to a phenomenon that Nicola Gennaioli, Andrei Shleifer, and Robert Vishny call “neglected risks.”11 They argue that certain unlikely events can materialize that are completely unexpected, because investors neglect the risks that they could happen. In the context of the housing crash, many investors may have neglected the risk of house prices falling more than 10 percent. During the financial crisis, people investing in money-market funds may have believed that no fund could ever “break the buck,” or pay back less than the nominal amount put in the account. Obviously, such neglect leads investors to make systematic mistakes and exercise poor economic decision-making. But Gennaioli, Shleifer, and Vishny show how the financial sector amplifies this neglect and produces a full-blown financial catastrophe. The key insight is that bankers will create securities that are vulnerable only to these neglected risks.


pages: 318 words: 77,223

The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse by Mohamed A. El-Erian

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activist fund / activist shareholder / activist investor, Airbnb, balance sheet recession, bank run, barriers to entry, break the buck, Bretton Woods, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, collapse of Lehman Brothers, corporate governance, currency peg, Erik Brynjolfsson, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, fixed income, Flash crash, forward guidance, friendly fire, full employment, future of work, Hyman Minsky, If something cannot go on forever, it will stop - Herbert Stein's Law, income inequality, inflation targeting, Jeff Bezos, Kenneth Rogoff, Khan Academy, liquidity trap, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Norman Mailer, oil shale / tar sands, price stability, principal–agent problem, quantitative easing, risk tolerance, risk-adjusted returns, risk/return, Second Machine Age, secular stagnation, sharing economy, sovereign wealth fund, The Great Moderation, The Wisdom of Crowds, too big to fail, University of East Anglia, yield curve, zero-sum game

And those of us on trading floors with direct exposure to all this were stunned by the difficulties faced in completing the most basic financial transactions—those involving the placement of cash into the financial system and the exchange of highest-quality collateral. I remember particularly vividly the day when the instability spread to the U.S. money market segment, with one large fund being forced to “break the buck” (that is, it was unable to meet its client redemption requests at par). In fact, markets had become so dysfunctional that day that I called my wife during the later California afternoon and suggested that she go to the ATM and withdraw the maximum allowed for us per day ($500 I think it was). When she asked me why, I responded that I felt there was some chance that the banks would not open the next day.


pages: 726 words: 172,988

The Bankers' New Clothes: What's Wrong With Banking and What to Do About It by Anat Admati, Martin Hellwig

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Andrei Shleifer, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bonus culture, break the buck, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversified portfolio, en.wikipedia.org, Exxon Valdez, financial deregulation, financial innovation, financial intermediation, fixed income, George Akerlof, Growth in a Time of Debt, income inequality, invisible hand, Jean Tirole, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Larry Wall, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, negative equity, Nick Leeson, Northern Rock, open economy, peer-to-peer lending, regulatory arbitrage, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Satyajit Das, shareholder value, sovereign wealth fund, technology bubble, The Market for Lemons, the payments system, too big to fail, Upton Sinclair, Yogi Berra

If the creditors are also financial institutions, the original bank’s distress or losses may cause these other institutions to also become distressed or insolvent, which can also cause their funding to break down. In September 2008, the bankruptcy of Lehman Brothers had a deadly impact on the Reserve Primary Fund, a money market mutual fund, which had lent almost $800 million to Lehman Brothers. As a mutual fund, it was funded by shares and thus was not threatened by insolvency. But when the losses on loans made to Lehman Brothers caused Reserve Primary to “break the buck”—that is, when the value of a share in the fund fell below one dollar—investors rapidly withdrew their money. Within days, Reserve Primary lost some $60 billion of its $62 billion in funds, and it was closed shortly afterward.9 At the time, investors in other money market funds, even those not directly affected by the Lehman bankruptcy, treated the fates of Lehman Brothers and Reserve Primary as a signal that other investment banks and money market funds might also be at risk.

By contrast to the U.S. law, the German law on banking regulation defines a credit institution (the German legal term for a bank) as any institution engaging in any one of a number of activities; using this approach, “banks” and “banking” are always the same. By this logic, money market mutual funds that allow customers to participate in the payment process should be treated like banks. In particular, if money market mutual funds promise a stable net asset value, this promise should be treated as a liability and the shares as deposits. Legally, the promise might not be binding, but when a money market fund “breaks the buck”—that is, when the value of its shares falls below $1—its “depositors” are likely to run in just the same way as the depositors of a bank. Money market funds are not explicitly insured by the deposit insurance system. Sponsoring institutions routinely provide them with backing. In the Lehman crisis, however, money market funds suffered a panic anyway until the federal government provided them with the analog of deposit insurance.


pages: 311 words: 99,699

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe by Gillian Tett

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accounting loophole / creative accounting, asset-backed security, bank run, banking crisis, Black-Scholes formula, break the buck, Bretton Woods, business climate, collateralized debt obligation, commoditize, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, easy for humans, difficult for computers, financial innovation, fixed income, housing crisis, interest rate derivative, interest rate swap, locking in a profit, Long Term Capital Management, McMansion, money market fund, mortgage debt, North Sea oil, Northern Rock, Renaissance Technologies, risk tolerance, Robert Shiller, Robert Shiller, Satyajit Das, short selling, sovereign wealth fund, statistical model, The Great Moderation, too big to fail, value at risk, yield curve

On September 16, the $62 billion Reserve Primary Fund, the country’s oldest money-market fund, posted a somber statement on its website: “The value of the debt securities issued by Lehman Brothers Holdings (face value $785 million) and held by the Primary Fund has been valued at zero effective as of 4:00 p.m. New York time today.” That threatened to spark more panic. America’s money-market fund industry had prided itself on never “breaking the buck,” and the Reserve had just done so. A run on the money-market funds now seemed likely. Meanwhile, as Steven Black and Vikram Pandit had anticipated, a crisis had been building at AIG. By the summer of 2008, AIG was holding around $560 billion in super-senior risk, such a gargantuan number and so little known outside the group that when some of the former J.P. Morgan team linked to the BISTRO trades later saw it, they assumed it was a typo.


pages: 460 words: 122,556

The End of Wall Street by Roger Lowenstein

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Asian financial crisis, asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, break the buck, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, fixed income, high net worth, Hyman Minsky, interest rate derivative, invisible hand, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, Rubik’s Cube, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

Money funds, regarded as the least risky of investments, were owned by millions of ordinary savers. In other words, financial engineers had contrived to connect safety-minded moms and pops to the mad cow of the financial world—exactly the stuff of which systemic crises are made. As the value of SIV paper plunged, the money market funds themselves became imperiled. Roughly a dozen of them were on the verge of “breaking the buck”—that is, the net asset value of these funds was about to fall below the par value of $1 that investors had come to assume was guaranteed. The funds’ sponsors were left with little choice: either they made good the losses, or their own investors would lose money and probably sell, creating a liquidity crisis among money funds and possibly an all-out panic. The sponsors of the funds, at least temporarily, averted a panic by contributing capital to paper over the losses (most investors never knew how close they had come to being burned).


pages: 543 words: 157,991

All the Devils Are Here by Bethany McLean

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Asian financial crisis, asset-backed security, bank run, Black-Scholes formula, break the buck, call centre, collateralized debt obligation, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Exxon Valdez, fear of failure, financial innovation, fixed income, high net worth, Home mortgage interest deduction, interest rate swap, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, market fundamentalism, Maui Hawaii, money market fund, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, shareholder value, short selling, South Sea Bubble, statistical model, telemarketer, too big to fail, value at risk, zero-sum game

In 1987, during the early days of mortgage-backed securities, a Merrill Lynch mortgage trader named Howard Rubin lost $250 million on one trade. That loss was big enough that Merrill stayed away from taking significant risks in the mortgage business for years. A decade later, during the Long-Term Capital Management crisis, Merrill struggled to maintain its liquidity, fearing at one point that its biggest retail money market fund might “break the buck,” a potential disaster. (O’Neal had been Merrill’s chief financial officer during the LTCM crisis.) “Anytime a trader lost $50 million,” recalls a former Merrill trader, “it was like the Spanish Inquisition.” You couldn’t take big risks without accepting the possibility of big losses, and that was something that Merrill just couldn’t stomach. Taking a lot of risk just wasn’t part of its culture.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bernie Madoff, break the buck, centre right, collapse of Lehman Brothers, collateralized debt obligation, commoditize, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, light touch regulation, Long Term Capital Management, mega-rich, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, too big to fail, trickle-down economics, value at risk, yield curve

It’s a rule that has protected me for thirty years. It’s a rule I urge you to follow yourself. That said, the first and biggest moral of this book is that you need to throw out all the assumptions you’ll have lived with to this point. Sovereign debt is no longer so safe you don’t have to think about it. (Truth is, it never was.) Banks might fail, including large ones. Money market funds may ‘break the buck’‌—‌that is, lose money. Equally, you need to shed some of your Ponzi-ish optimism. House prices have fallen, but they may fall further. Stock market prices have fallen, but they may fall further. Some bond prices have already collapsed, but they could collapse further. The dollar has collapsed against the yen (falling by a third, from $1 = ¥120 in 2007 to less than ¥80 at the time of writing).


pages: 444 words: 151,136

Endless Money: The Moral Hazards of Socialism by William Baker, Addison Wiggin

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Andy Kessler, asset allocation, backtesting, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Branko Milanovic, break the buck, Bretton Woods, BRICs, business climate, capital asset pricing model, commoditize, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, cuban missile crisis, currency manipulation / currency intervention, debt deflation, Elliott wave, en.wikipedia.org, Fall of the Berlin Wall, feminist movement, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, housing crisis, income inequality, index fund, inflation targeting, Joseph Schumpeter, laissez-faire capitalism, land reform, liquidity trap, Long Term Capital Management, McMansion, mega-rich, money market fund, moral hazard, mortgage tax deduction, naked short selling, negative equity, offshore financial centre, Ponzi scheme, price stability, pushing on a string, quantitative easing, RAND corporation, rent control, reserve currency, riskless arbitrage, Ronald Reagan, school vouchers, seigniorage, short selling, Silicon Valley, six sigma, statistical arbitrage, statistical model, Steve Jobs, The Great Moderation, the scientific method, time value of money, too big to fail, upwardly mobile, War on Poverty, Yogi Berra, young professional

It not only transfers money from those who use it judiciously to those who are wanton, it orders holders of wealth to henceforth protect their capital by withdrawing it from countries that are stripping rationality from the investment market, to exchange it for gold, to short equities, and take other protective measures. What could be more damaging than creating the unpredictable circumstance where investors in short-term interestbearing funds cannot be certain whether these will break the buck as liquidity is withdrawn? Bloomberg Magazine authors Seth Lubove and Daniel Taub presciently depicted the regional corruption of credit in their portrayal of practices in southern California in an article titled “Subprime Fiasco Exposes Manipulation by Mortgage Brokers”dated May 30, 2007. They begin by relating the sudden transformation of a 27-year-old employee at Target, impressed by cars, girls, and cash being bandied about by Moral Hazard 149 his mortgage broker friend, who joins Secured Funding, one of several subprime originators based in California that collectively wrote 40 percent of the nation’s subprime loans for several years.

Investment: A History by Norton Reamer, Jesse Downing

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

The public became so disenchanted by the decline in many mutual funds that Business Week noted that the fund industry had “an image problem.”71 However, during this period, the first money market mutual fund, the Reserve Fund, was founded by Bruce Bent and Henry Brown.72 The goal of this vehicle was to take very little market risk and preserve capital while earning a small but steady return. Investors were attracted to these funds because of their circumvention of Regulation Q that otherwise capped the interest rates savings institutions could pay, which was a large problem during this inflationary period. The central mission of these funds was to generate returns while not “breaking the buck,” or having the net asset value decline below $1 per unit. Indeed, these funds rarely failed at their mission, with the exception of some funds during the financial crisis of 2007–2009, including, in fact, Bruce Bent’s own Primary Reserve fund, which had some exposure to Lehman debt. Mutual funds experienced vast asset growth in the 1990s because of three factors. First, mutual funds gained assets through price appreciation as well as investors’ enthusiasm in the bull market of 144 Investment: A History the 1990s.


pages: 598 words: 169,194

Bernie Madoff, the Wizard of Lies: Inside the Infamous $65 Billion Swindle by Diana B. Henriques

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accounting loophole / creative accounting, airport security, Albert Einstein, banking crisis, Bernie Madoff, break the buck, British Empire, centralized clearinghouse, collapse of Lehman Brothers, computerized trading, corporate raider, diversified portfolio, Donald Trump, dumpster diving, Edward Thorp, financial deregulation, financial thriller, fixed income, forensic accounting, Gordon Gekko, index fund, locking in a profit, mail merge, merger arbitrage, money market fund, Plutocrats, plutocrats, Ponzi scheme, Potemkin village, random walk, Renaissance Technologies, riskless arbitrage, Ronald Reagan, short selling, Small Order Execution System, source of truth, sovereign wealth fund, too big to fail, transaction costs, traveling salesman

The overall market was down a stunning 5 percent yesterday as regulators grappled with whether, and how, to rescue AIG, which was on the brink of defaulting on its derivative-based obligations to other giant institutional investors around the world. The Treasury announced a rescue package for AIG this morning, but unexpected cracks from the impact of Lehman Brothers’ collapse are showing up elsewhere. Today, The Reserve fund, the nation’s oldest money market fund, “breaks the buck” by reporting a net asset value of less than a dollar a share. The news feeds the growing panic. If this financial crisis can infect even supposedly secure money funds, for decades the middle-class substitute for a bank account, there is no safe haven. At Fairfield Greenwich Group, whose wealthy investors have long thought of Madoff as a sort of plutocratic money market fund, clients are seeking clarity and comfort.


Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business process, butterfly effect, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, Chance favours the prepared mind, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical arbitrage, Steven Pinker, stochastic process, survivorship bias, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

The interbank lending system began to freeze up; banks found it harder and harder to borrow from each other, because no one knew for sure whether a counterparty would still be solvent the following week. Once Lehman Brothers declared bankruptcy on September 15, 2008, the bonds issued by this venerable 158-year-old investment bank became nearly worthless. The next day, the Reserve Primary Fund, a money market fund with about $65 billion in assets, announced that they were “breaking the buck”—shares in their fund that were supposed to be valued at $1.00 were now worth 97 cents. Many customers treat their money market funds like a bank’s checking account; what would you do if your bank told you that the assets in your checking account just lost 3 percent in value overnight? The difference is that the Federal Deposit Insurance Corporation (FDIC) insures the assets in your checking account up to $100,000, while money market funds were not insured at that time (now they are).