During the worst days of 2008, something strange happened. During the Eight Days of Terror, the S&P 500 fell by 23% but there were no loud calls for the government to guarantee the value of stocks (Aside: TARP was signed into law on Day 3 of the 8).
By contrast, about two weeks beforehand, Treasury guaranteed
the solvency of many money market mutual funds
, the de facto
bank accounts created by investment companies. Why the guarantee? Because of the panic induced by one
money market mutual fund (MMMF) when it announced that its value had plummeted: Instead of being able to repay 100 cents on the dollar, the Reserve Fund would only be able to pay—-wait for it—ninety-seven cents.
Yes, the Reserve Fund was an historically important MMMF–it was the first. And surely its failure contained a signal about the health of the others. But three cents on the dollar? That set off a mad scramble for safety that spurred the Bush Treasury to create a new government guarantee?
There’s a lesson here.
The lesson shows up again in the bank bailouts: Bondholders of the biggest banks never lost a penny of principal, but megabank shares lost most of their value in the crisis.
Politicians treat depositors and megabank bondholders quite differently than they treat shareholders. The former get bailed out regularly while the latter get…whatever is left.
People often think of the bailouts as good news for shareholders. But it’s far, far better news for bondholders. Wisely, megabank bondholders have stayed very, very quiet about their good fortune.
Bond and deposit promises hold a special place in people’s hearts. There’s something about the line on the contract saying “You shall be repaid $10,000 on 1 December 2014” that gives people a sense of entitlement that they carry all the way to the Senator’s office.
Yet another debt externality.