It’s hard to believe that it’s been a year.
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On Sept. 7, 2008, James Lockhart, director of the Federal Housing Finance Agency, FHFA, better known as Fannie Mae, stepped in front of the cameras and announced that Fannie Mae and its companion lender, Freddie Mac, were being placed into a government conservatorship.
It was one of the most sweeping governmental interventions into the private financial markets in decades. At the time, Fannie and Freddie owned or guaranteed about half of the U.S.’s $12 trillion mortgage market.
Although Bear Stearns already had been bolted onto the Bank of America portfolio in March, this was the initial temblor in the tectonics that shook the financial markets and changed the face of Wall Street.
Blindsided
One week later, when then-Treasury Secretary Hank Paulson and Fed Chair Ben Bernanke refused to come to its aid, Lehman Brothers collapsed. The result was the largest bankruptcy in U.S. history.
The cascade of events triggered by the faltering of Freddie Mac and Fannie Mae combined with the implosion of Lehman Brothers was dramatic and unexpected.
By Friday of that week, the Reserve Primary Fund, RFP, one of the country’s largest and most stable money market mutual funds, with $62.2 billion in assets, was in serious trouble. After the Lehman Brothers’ announcement, at least a dozen investors pulled $40 billion out of RFP, stripping the fund of nearly two-thirds of its once formidable asset base.
These investors fled the safety of the RPF because they knew that the fund held a scary batch of mortgage-backed securities underwritten by Lehman Brothers. This touched-off a financial wildfire that resulted in a modern-day run on the bank.
For the first time in recent memory, RFP broke the buck.
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Prior to that point, most investors considered money market mutual funds like RFP to be a safe haven. While the returns were always modest, investors knew that their original net asset value would be protected. In other words, if you invested a dollar in the likes of RFP, you may not make very much, but the value of your investment never will drop below its initial value.
The withdrawals meant the RFP had to break the buck. That is, its net asset value sank below the time-honored standard of $1 a share.
When No One Was Looking
The cruel irony is that when the money-market concept was conceived nearly three decades earlier, it was founded on the notion of sober-minded investing. The fundamental idea was that money market mutual funds should be so boring as to put their investors to sleep.
The Lehman debt, whose face value was $785 million, had to be written down to zero. That pushed the fund's per-share price down to $0.97, jolting to money market investors world-wide.
That led to panic. Frightened investors began pulling their savings out of these funds. In the end, the federal government stepped in to offer a temporary guarantee for the $3.6 trillion in money fund assets.
In reality, the net asset value, or NAV, of money market mutual funds like RFP had always marginally fluctuated above and below the their $1 a share standard. But when no one was looking, fund managers started seeking higher yields over security.
Some funds began buying riskier investments to produce those higher yields without disclosing the risks to their investors. This led to the funds loading their portfolios with so-called triple AAA-rated subprime mortgages underwritten by Lehman.
These events pushed Paulson and Bernanke, along with President Bush and key members of Congress, to burn the midnight oil while they looked for measures to calm the financial markets. From this desperation, TARP (Troubled Asset Relief Program) was hatched to provide the nation’s largest banks with the liquidity they allegedly needed to survive.
A Time to Morph
Overnight, many of the Wall Street investment banks like Goldman Sachs and JP Morgan Chase that had created the highly leveraged instruments that led to Lehman’s demise were allowed to convert themselves into regulated institutions so that they could take advantage of the $700 billion federal bailout.
The financial situation was made all the more precarious by sharp increases in food and energy prices. With a sudden swiftness, sub-prime losses started to pile up, causing major lenders, like Countrywide and Washington Mutual, to call it quits. Predictably, share prices declined precipitously, decimating stock portfolios values at every level.
By March of this year, the markets began to stabilize. Share prices since have seen a dramatic rise from their record lows. While firms at the top of the food chain have started to report signs of a recovery, credit still remains tight. Consumer spending, which makes up almost 70 percent of our national prosperity, is anemic.
Nationwide, unemployment is hovering near 10 percent. In some regions, like Michigan and California, it is in the mid-teens. Prior to the recession, American jobs were being outsourced at a record pace. Now many of the jobs coveted in the American labor force have been eliminated and will not likely ever return.
The challenge of rebuilding the U.S. economy from this devastating episode will take more than simply stabilizing key financial institutions. It will take more than the regulatory reforms being proposed to keep the financial industry in check.
It will take jobs … jobs … and more jobs. If Americans are not working, they can’t save or spend.
Mr. President, reforming our healthcare system is important. But what good is a great healthcare plan if millions are still out of work and won’t be able to afford the mandatory premiums, no matter how cheap they become.
You must find ways to help small businesses create new industry and jobs. Because the banks are still not lending at the middle or bottom, they must be by-passed.
If you squander all of your political capital on healthcare, this never will be accomplished, especially with mid-term elections quickly approaching next year.
While some opposed it, I applauded your televised pep-talk to America’s school children today. But your encouragement to our youth is hollow if the America they will inherit does not hold the promise it once held for their parents or grandparents.
It’s been a year since Fannie Mae and Freddie Mac stumbled. What a year.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
