When a Fund Bet on a Bailout
By Arnold Kling
From July 2007 to July 2008, the commercial-paper portion of Reserve Primary’s holdings jumped to almost 60 percent from 1 percent, according to the trade association. The fund’s yield rose to 0.4 percentage point above the average among its peers in 2008 from slightly below average, a substantial increase by money market standards
…One of the “peas” Bent acquired as part of his move into commercial paper was debt issued by Lehman in August 2007. After the demise of Bear Stearns Cos., Reserve replaced $375 million of Lehman debt that matured in March 2008 with $385 million in new Lehman issues, the ICI reported. The Lehman investment eventually rose to $785 million.
A point that the article fails to make but that I will is that Lehman was widely known to be a troubled firm at the time that Reserve Primary was loading up on its commercial paper. That investment was nothing other than a bet that Lehman would be considered “too big to fail.”
We had, and still have, a financial system in which such bets make sense. I see that as a problem. The financial reforms on the table do not address that problem. If anything, they exacerbate it. They promise, in effect, to make firms “too regulated to fail.” Ultimately, that is an inherently self-denying promise.