Paulson's Money Market Bailout Had No Clothes...

On Thursday September 18, 2008, with global stock and money markets descending in panic, Hold 'Em Hank Paulson announced an emergency program (bluff) to stabilize markets that would utilize a $50 billion fund, that was actually designated for another purpose, to guarantee $2.4 trillion in money-market mutual fund assets, or 99% of the U.S. total.

Until yesterday, details of this $2.4 trillion bailout program were a closely-held secret, only made public through a FOIA request by finance professor Dr. Linus Wilson. Wilson's reveal illustrates a point we have made repeatedly regarding bailouts and various federal banking guarantees:

At their core, most are rubbish. Little more than words and secret prayer sessions by central bankers. In this case, the last we checked, $50 billion is exactly 2.08% of $2.4 trillion.

Put another way, Paulson was using X to guarantee 48X in assets.

Luckily for Paulson, the bluff worked and order was restored.

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John Carney - CNBC

Excerpt:

Details about a secretive government program to bail out money-market mutual funds are finally coming to light.

Acting without any explicit Congressional authority, the U.S. Treasury guaranteed in excess of $2.4 trillion of money market funds after the giant Reserve Primary Fund "broke the buck" following the bankruptcy of Lehman Brothers. The program, which ended on Sept. 18, 2009, seems to have successfully prevented a panicked run by money-market fund investors.

But until now, the Treasury has kept the identities of the funds that received government backing and the amounts guaranteed secret. It was not clear how many funds obtained backing or for how much taxpayers were on the hook during the program's duration.

Linus Wilson, an assistant professor of finance at the University of Louisiana at Lafayette, recently obtained data about the program from the Treasury, through a Freedom of Information Act request. The data from the Treasury show that taxpayers were backing in excess of $2.4 trillion through the mutual fund program. Hundreds of funds participated in the program, amounting to almost 99 percent of the total money-market mutual fund assets.

Mutual fund companies such as BlackRock, BNY Mellon, T. Rowe Price, Dreyfus, and Legg Mason took advantage of federal assistance, plus large banks that provide money market funds to customers, including JPMorgan, Goldman Sachs, Morgan Stanley and Wells Fargo.

Despite the enormous size of the guarantees, the Treasury collected only $1.2 billion in fees from the participating funds. By Wilson’s calculation, most participating funds paid just 0.04 percent, or 4 basis points, for a year’s worth of insurance.

Treasury used $50 billion from an account set aside for exchange rate stabilization to fund the program. Those funds can be spent at the Treasury Secretary’s discretion—even when it takes a pretty creative logical leap to connect the expenditures to exchange rates.

“Clearly, the tie between exchange rates and money-market mutual funds is very weak,” Wilson points out. “Moreover, it is not clear that $50 billion was enough to guarantee over $2 trillion in assets.”

Guaranteeing the money-market funds was not without risk. Although money-market funds have rarely seen their values drop below a dollar, guaranteeing the funds, it could be argued, encouraged moral hazard as investors lost the incentive to police the quality of fund management.

Continue reading...

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Listen as Kanjorski describes Paulson's threats:

Transcript of Rep. Paul Kanjorski statement on C-SPAN:

"It was about September 18th [sic]. … On Thursday at about 11 o’clock in the morning the Federal Reserve noticed a tremendous drawdown of, uh, money market accounts in the U.S. to the tune of $550-billion was being drawn out in in a matter of an hour or two.



The Treasury opened up its window to help, and pumped in $105-billion into the system, and quickly realized it could not stem the tide. We were having an electronic run on the banks. They decided to close down the operation, to close down the money accounts. … If they had not done that, in their estimation, by 2 PM that afternoon $5.5-trillion would have been withdrawn and would have collapsed the U.S. economy and within 24 hours the world economy would have collapsed. We talked at that time about what would have happened. It would have been the end of our economic and our political system as we know it."

For more detail on this clip:

Background: