The Federal Reserve just released transcripts from the 2008 Federal Open Market Committee meetings.
The FOMC held a regularly-scheduled meeting on Sep. 16, 2008 — the day after Lehman Brothers filed for bankruptcy, an event that sparked turmoil in global markets.
At the outset of the meeting, then-chairman Ben Bernanke called for the establishment of dollar swap lines with G-10 central banks in order to ease funding strains in global markets.
“I would like to put on the table a request for authorization for swap lines,” said Bernanke, according to the transcript.
“I prefer not to put a limit on it, so I know I’ve got my own bazooka here.”
After Lehman went down, funding costs began to rise in wholesale interbank lending markets. As the transcripts make clear, the FOMC was concerned that it would be harder for other banks to secure funding, causing the crisis to spread.
During the meeting, New York Fed president Bill Dudley explained the risk:
Now, the Lehman filing has also intensified the pressure on Morgan Stanley and Goldman Sachs in a number of respects. The Lehman failure means that investors now view the debt of Morgan Stanley and Goldman Sachs as having much more risk than it did on Sunday. This means that these firms need bigger liquidity buffers than they had before, and it does have implications for long-term profitability.
As a consequence, their share prices fell very sharply yesterday. Morgan Stanley was down about $US5 a share, to $US32, and Goldman Sachs’s stock was off 18 points, to $US135. Morgan Stanley experienced a modest, but not insignificant, pulling back of their counterparties and ate into their liquidity buffer by a measurable degree.
The Lehman problems also were evident in some other areas. This is very incomplete, but the ones that came to my attention were money market funds — especially, the Reserve Fund that had large withdrawals, and they encountered a significant liquidity problem. I am actually not sure how that was resolved, but I think that State Street was in the situation of having to cover a very large shortfall of the Reserve Fund last night.
The risk here, of course, is that, if AIG were to fail, money funds have even a broader exposure to them than to Lehman, and so breaking the buck on the money market funds is a real risk. The capital resources of the entities that are associated with the money market funds often are quite modest, so their ability to top up the money funds and keep them whole is quite limited. Thus the money market funds are definitely one important issue in how this contagion could be broader.
Bernanke got his bazooka. On the same day, Primary Reserve Fund — the country’s oldest money-market fund, broke the buck. And, of course, funding costs continued to rise, the crisis spread, and the government ended up having to bail out AIG.
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