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.
Pointer from Andrew Leonard via Mark Thoma.
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.
READER COMMENTS
Dan
Sep 10 2009 at 9:43am
It’s always interesting how our priors affect our reaction to new information. Leonard sees this story and concludes that we can’t rely on markets for risk management and self-correction. It doesn’t occur to him at all (or at least he makes no mention) that the government created a huge moral hazard by facilitating the Bear bailout a few months earlier.
David R. Henderson
Sep 10 2009 at 10:52am
Arnold,
“Too regulated to fail.” That’s a keeper.
Best,
David
Yancey Wardt
Sep 10 2009 at 12:46pm
One of the things I find so funny is all the people complaining that risk was mispriced for years. But, with all the bailouts (see AIG), was the true risk badly mispriced? Looking out over the entirety of what has happened, the entities that mispriced risk the most were government institutions.
Don the libertarian Democrat
Sep 10 2009 at 3:56pm
“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.”
What I’ve been trying to argue is that this was our system prior to Lehman. In other words, almost all of the bets were against Lehman being allowed to fail. People were not prepared for anything else. To verify this, all that you need to do is read the accounts of actual investors from the week of Lehman. Investors were scrambling into cash. I’m sorry, but that is a disaster in today’s interconnected financial market, because a lot of people in that scramble will go bust.Too many.
We need to change the system. But it’s going to take time. In my mind, this necessitates having a long term strategy that allows for slow but steady progress. Of course, I’ll accept big changes if they’re to my liking.
Comments are closed.