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Comment by ryanwaggoner | Hacker News Reader

Can someone explain this to a non-finance / non-macroeconomics type? Was it foreigners who were pulling money out? Was it people in the US? If they pull $5.5 trillion in cash out, where would it have gone? Just don't understand why everything would have collapsed.

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This was a bank run, except it involved money market accounts. Money market accounts hold a lot of short term corporate debt. After Lehman went bankrupt, a few prominent money market accounts that held Lehman debt "broke the buck", ie paid out less than what investors put in. Since money market accounts weren't insured at the time, this set off a panic. People likely called their fund managers, trying to redeem their funds, to move it to FDIC insured bank accounts. If fund managers tried to redeem over 50% of their funds at once (as some funds experienced), that would explain hundreds of billions of dollars draining out in an hour.

If the money market accounts crashed, financial companies wouldn't have been able to roll over their short term debt, which they rely on for day-to-day operations. Non-depository institutions (like the surviving investment banks) would be forced into bankruptcy. Those bankruptcies would cascade, and depository institutions would fail as well, probably with bank runs on accounts over the FDIC limit.

What made the Great Depression great were the banking crises. Without a functioning financial system, a modern economy can't grow. And if we reached a point where people couldn't even get money out of ATMs, we're talking about complete social breakdown. One Congressman claimed the administration talked about martial law as a real possibility. We really did come close to the brink. And the downward cycle went even faster than prescient bears like Nouriel Roubini thought it would.

> Non-depository institutions (like the surviving investment banks) would be forced into bankruptcy.

Forced by whom?

Banks are required by govt law to have more assets than liabilities, but many institutions and individuals owe more than they have to no ill effect.

In the short-term, cash flow is the only thing that matters and even that is under some control. A bank can "simply" refuse to pay money that it doesn't have.

Yes, there will be consequences, but later, giving the bank time to do something useful.

However, current govt reserve requirements don't allow that.

Yes, I know the reason behind such requirements. My point is that they make certain bad situations worse and it's not clear that such amplification is required for the claimed benefits.

These aren't just banks. These are all corporations in the modern world, period. Everyone from Target to Citi issues notes in the money markets.

And yes, the banks are required to have more assets than liabilities. But that has nothing to do with the money markets or day to day operations.

Here's a crappy, but workable analogy. What do you do in a modern computer? Have enough money for all the programs that are running, up front? Or do you have some shared virtual pool of memory?

The money market is kind of like that. It's silly for each and every corporation to have all the cash on hand it needs for day to day operations. That would require a lot of money that would be sitting around doing nothing. A much more efficient system is to have lenders who dole out short term loans (that pay darn little but are almost guaranteed to pay back) to the corporations as they need them.

Suppose that January is just a nasty month, and Target has to dole out lots of money to its health insurance benefits. That's fine, they'll just issue more commercial paper, and it will all work out when they tally up the bills at the end of the quarter.

Without that money market, what would happen instead is that Target would either have to keep a lot more money lying around, or run into a brick wall if something bad happened. It's like forcing everyone to buy many times more memory for their computer than they would need in everyday situations.

assets != cash. Also, if the cash reserves die out, they will probably fall short of the reserve requirements in place.

I didn't say (write actually) that assets are cash.

I asked who would force the banks into bankruptcy and suggested that not doing so (immediately) might have been better than a total financial system collapse, which was supposedly the only other alternative to the massive cash infusions.

When I run out of cash or my liabilities exceed my assets (short term or long term), no one shuts me down immediately. I keep collecting cash and spend it as it comes in. The folks who I owe money to aren't happy when I skip payments, and eventually that affects my ability to do biz on anything other than a cash-basis, but there's no immediate shutdown.

In fact, most US bankruptcies are initiated the debtors, not the creditors, so the debtors can get out of unprofitable deals. (This isn't true in the UK.)

But we treat banks differently. As soon as they reach certain financial "targets", we shut them down. This is a choice that has consequences.

Thank you, that's the clearest explanation of this whole thing that I've read to date.

Sometimes I wonder what would've happened had corporations actually found the commercial paper markets totally frozen (as opposed to mostly frozen) and themselves unable to finance daily operations. Would they really say "Okay everybody go home, we have no money" or would they say "Well fuck, nobody knows if hey're gonna get paid, but we got nothing better to do, so we might as well continue doing business."

The economy as a whole seems remarkably resilient considering that it's all built on confidence. In cases where trade completely collapses, firms often "evolve" an alternative currency - scrip, cigarettes, foreign currencies, paper ledgers. I wonder if established firms with longstanding business relationships would've just said "Well, nobody can get cash right now, but I'll make an entry in our Oracle database and we can sort out the mess later."

> financial companies wouldn't have been able to roll over their short term debt, which they rely on for day-to-day operations

The fact that they rely on debt for day-to-day operations should be a red flag that they are doing something wrong.

I think it's mostly as a way to smooth out their financial numbers, even companies with tons of money in the bank still uses short term debt on daily basis... at least that was how a business owner explained it to me.

> smooth out their financial numbers

So how will they fail if they don't have access to it?

Excess inefficiencies if they have to adjust immediately. They would have to unroll all the debt in a few days instead of the months it would take to unroll the debt in an orderly fashion.

That's not the way the commercial paper market works. Many companies use this for payroll and managing cash. It makes sense to use someone else's money when the interest rate is low enough that you can put your own cash into better use.

I wouldn't be too critical about this practice unless you have experience as a treasurer or CFO.

I'm not saying it doesn't make sense given the environment that they work in.

I'm saying that the environment that they work in doesn't make sense.

It is interesting, for cultural and for business reasons, most tech companies do not use debt markets. (Tech companies-- especially software companies-- generate lots of cash flow and aren't as capital intensive as other industries).

There are also federal tax breaks that encourage the use of debt financing.

Your country's tax system is not alone in that regard.

Without a functioning financial system, a modern economy can't grow.

This is a good line - with all the (justifiable) negativity around at the moment it's easy to forget that we still need (good) finance to move forward.

Only one broke the buck, the Reserve Fund. And they shouldn't have been anywhere near risky Lehman debt. That's what sparked the run-- people wanted out of the Reserve Fund and other investors were freaked that other money markets holding similar risky paper. The situation was fixed directly with a federal guarantee for money markets-- but the example was used as part of the fear-mongering to pass the TARP, which has absolutely nothing to do with money markets.

Also money markets/commercial paper debt markets are important to all businesses issuing short term debt, not just financials.

> And if we reached a point where people couldn't even get money out of ATMs, > we're talking about complete social breakdown.

And in a country like USA it would mean a civil war. People have a tendency to freak out too much, like post 9/11. I don't see the Argentinean-style civil protests and spontaneous grassroots organizations. I'd bet on dog-eat-dog. (I write this with sadness.)

Come on, sure it would be hard on people, but it would not mean a civil war. --Exactly who do you think would be fighting who? The government would be doing all they could to get people access to their money, and while there will always be idiots out there, the population isn't quite as stupid as you might like to believe (even though a majority technically voted for Bush once).

I wonder how long people will say "called their fund managers" when really most just use their dedicated app or log into a website and click a few things.

When you're talking about wealth in the multi-millions and even billions, many people do employ money managers. I have friends who work at small money management firms that have only one or two clients.

A better question is: Where would it have come from? Most of the assets backing money market funds are short-term obligations to repay from a broadly diversified range of borrowers, usually corporate or municipal, with a small amount of cash to facilitate transactions. The terms of those loans to companies and local governments don't allow the bank to just demand the money ahead of schedule. The assumption is that when one particular fund experiences a high volume of withdrawals, it will be able to sell its commercial-paper assets to other banks, or as a last resort, borrow from the Fed to cover the withdrawals. The extraordinary event here was that there was such a massive panic across the entire country, not even the Fed would have been able to keep up.

Incidentally, what touched off this panic was when two money market funds "broke the buck" on the same day; that is, instead of paying their investors an interest dividend, they announced that their investors' deposits had shrunk (by a small amount) from the day before. Depositors thought the financial crisis was about to consume money market accounts, panicked, and moved their cash from non-FDIC-insured MM accounts into regular checking accounts.

The funds would have simply vaporized. The actual supply of green dollar bills in the world is about $800 billion. But money market funds are valued at $8 trillion. If everyone actually tries to redeem their shares for dollars, each share would ends up being worth pennies on the dollar.

Instead, the Fed stepped in an backed up the funds with the full faith and credit of the U.S. government. Essentially, the Fed monetized the money market funds.

mattobrien's explanation was awesome. A lot about the current crisis was demystified for me in an episode of This American Life: http://www.thisamericanlife.org/Radio_Episode.aspx?episode=3...

I'd recommend this to anyone who's looking for a well-explained overview. Set aside an hour or so to give it a listen.

If true, this was part of a flight to government-guaranteed debt such as US Treasuries and away from debt such as corporate and municipal bonds. This has been called the flight to 'quality,' but of course the only quality inherent in government debt is that the government can always print more money rather than defaulting. Of course, once a substantial block of assets receives this guarantee, investors demand a premium for debt that _lacks_ this guarantee. Existing corporate bonds didn't have this premium, so everyone wanted rid of them once the government expanded guarantees to cover nearly everything but corporate debt. And since money market funds held substantial portfolios of corporate bonds, investors wanted their money out of money market funds.