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The Electronic Run on the Banking System

- September 11, 2008 -
The real cause of the 2008 financial crisis
Redaction: Hubert Luns
In an interview on CSPAN (a television network) on January 27, 2009, Representative Paul E.
Kanjorski explained how the Federal Reserve reacted to a tremendous draw-down of money market
mutual funds in the United States “to the tune of $550 billion dollars (per half hour)”, the largest
singular transfers of money in history in such a short time frame. (Kanjorski, popularly known as
Kanjo, is a Democratic member of the U.S.
House of Representatives, representing Penn-
sylvania.) According to his testimony, this flood
of electronic transfers occurred over the period
of an hour or two. The resulting outflows threa-
tened the stability of the short-term funding
markets, particularly the commercial paper
market upon which corporations rely heavily
for their short-term borrowing needs.

It took close to five months for this information,

concerning a deliberate run on the banks, to be
made public. Already on September 15 Trea-
sury Secretary Paulson and Chairman of the
Federal Reserve Bernanke testified before Con-
gress that on the previous Thursday an “electronic run” on the U.S. banking system took place
between the hours of 9 and 11 AM. Congressman Kanjorski ended his comments by saying “some-
one” was responsible for the slashing of that financial jugular that nearly bled America to death.

1 – Strange things happening…

Says Mark Glenn in his newsletter: “The fact that it took close to five months for this information
concerning a deliberate run on the banks to be made public is proof that the captain and crew of
the Titanic have decided to allow the passengers to go about their lives unencumbered, while they
try to find a way to deal with the current situation.” Robert Wenzel wrote in the Economic Policy
Journal on account of these revelations:

«« I attended a speech given by Fed chairman Ben Bernanke at the National Press Club in
Washington D.C. on February 18. Much to my amazement he mentioned the September
2008 period twice. Once in his prepared remarks and once during the question and answer
session. The prepared comment ran as follows: “Together with other government programs,
our actions to stabilize the money market mutual fund industry have also shown some
success, as the sharp withdrawals from funds seen in September have given way to modest
inflows.” Since the Congressman Kanjorksi comments about the panic withdrawals, the Fed
has obviously decided, given that we live in the age of the Internet, to simply go with the
flow and act as though it was a known fact about heavy mutual fund withdrawals across the
board. It wasn’t. I was looking for such stories back in September because of the problems at
Reserve Primary Fund. Those stories weren’t there. But more important than
acknowledgements of the withdrawals, is the panic it caused. It completely reversed Fed
policy (which until then was geared to a very tight money supply). »»

According to US World and News Report and Bloomberg of September 17 and 18 (still available
on the Internet at the time of writing in April 2010), the Reserve Primary Fund - which has highly
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liquid assets - lost more than 60% if its assets due to redemptions after doubts had arisen on the
value of its Lehman Brothers holdings. Robert Wenzel wrote in the Economic Policy Journal on
September 16, 2008:

«« News that the Reserve Primary Fund, the oldest money market fund in the country with
$ 64 billion under management, has broken the buck (redemption at less than 100%) and
frozen resumptions for seven days, is not good. Edges of panic are beginning to appear
throughout the system. (He later wrote:) But there was little about money market stories
outside of specific news on the Reserve Primary Fund. In fact stories about money market
funds were disappearing! »»

On September 18, Wenzel posted the following comment on his website:

«« The Fed is now backstopping the mutual fund industry and, yet, corporate officials are
apparently still hesitant to park money there. My inquiring mind wanted to know more. I
clicked on the story. Poof, Wham, Bam, Gone. I even googled the first sentence. No luck.
The only link that showed up is a dead link. I hope the reporter survived. File under
censorship? Even the news on heavy redemptions at Reserve Primary was being buried.
Somebody didn’t want a negative money market fund story out, somebody who had the
ability to get to the media and shut down the story. Guess who that might be? »»

The day on which the financial hemorrhaging is said to have taken place, September 11, 2008, is
the exact date of the Twin Towers debâcle in New York, seven years earlier. The financial
hemorrhaging was between 9 and 11 AM, which coincides with the time frame of the planes
crashing into the Twin Towers on September 11th, 2001 !! The financial crisis – rather than being
an accident – might be another act of sabotage on the part of the same malicious entity who has
acted before, but if so, its timing was perfect in view of the already very weakened condition of
the U.S. financial system. Based upon my understanding of the markets, I think this kind of
manipulation is just not possible! It was a mass-psychological thing.

2 – The video Interview with Congressman Paul Kanjorski

Here follows the transcript of the Kanjorski interview on January 27, 2009, related to the draw-
down of money market funds, also available at his website of the House of Representatives:

«« Why did we do that (supporting Wallstreet and not Mainstreet - the common man)? We
did that because the Secretary… look, I was there when the Secretary (of the Treasury) and
the chairman of the Federal Reserve came those days and talked with members of Congress
about what was going on, it was about September 15th (a monday). Here’s the facts; and we
don’t even talk about these things.
On (the previous) thursday (Sept. 11) at about 11 o’clock in the morning the Federal
Reserve noticed a tremendous draw-down of money market accounts in the United States to
the tune of 550 billion dollars (per half hour), being drawn out in the matter of about an hour
or two. The Treasury (actually, the Federal Reserve) opened up its window to help and
pumped $105 billion in the system, and quickly realized they could not stem the tide. We
were having an electronic run on the banks. They decided to close the operation, close down
the money accounts and announce a guarantee of $ 250,000 per account so there wouldn’t be
further panic out there. And that is what actually happened. If they had not done that, their
estimation was that by 2 o’clock that afternoon, 5.5 trillion dollars would have been drawn
out of the money market system of the United States, (which) would have collapsed the
entire economy of the United States. And within 24 hours the world economy would have
collapsed. (Remark: the 5.5 trillion represents 42% of the annual GNP of the U.S.)
Now, we talked at that time about what would happen if that happened. It would have
been the end of our economic system and our political system as we know it, and that’s why,
when they made the point, we got to act and do things quickly – we did. Now, Secretary
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Paulson said: “Let’s buy out these subprime mortages.” That’s what he came to (do in)
Congress. They said: “Give us latitude and large authority. Give you many things as we
decide necessary and give us $ 700 billion to do that.” Shortly after we enacted our bill with
those very broad powers, the United Kingdom came out and said: “No, we don’t have
enough money to buy toxic assets. We’re instead, we are going to put our money into banks,
so that their equity grows and they are not bancrupt.” And so the U.K. started that process.
And that’s true. It was much cheaper to put more money in banks as equity investments than
to start buying their bad assets, because it became early determined that we gonna have to
spend $ 4 or 3 trillion of taxpayers money to buy these bad assets and we did not have – we
only have $ 700 billion dollars.
So, Paulson made a complete switch, went in and started putting money and buying
securities and reinvest in the banks of the United States. Why? Because if you don’t have a
banking system, you don’t have an economy, and although we did that, it wasn’t enough
money. And as fast as we did that, the economy has been falling and the reason last week…
We’re really no better off today than we were three months ago, because we had a decrease
in the equity positions of banks, because other assets are going sour by the moment.
(…) Somebody threw us in the middle of the Atlantic Ocean without a life raft and
we’re trying to determine which is the closest shore and whether there’s any chance in the
world to swim that far. We don’t know !! »»

3 - A chronicle of the Lehman debâcle

Because the Lehman event was so crucial in the coming about of the crisis, I will discuss this in
more detail. In 2008, Lehman Brothers faced huge losses due to the mortgage crisis. They were
the result of having held to large positions in the subprime and other lower-rated mortgage tran-
ches that resulted from the issuance of mortgage-backed securities by the firm. In the second
quarter, Lehman reported losses of $ 2.8 billion and was forced to sell off $ 6 billion in assets. In
the first half of 2008 alone, Lehman’s shares lost 73% of their value, but in the week leading up
to August 22 they closed up 16% on reports that the state-controlled Korea Development Bank
was considering a take-over. Two weeks later, on Tuesday September 9th, Lehman’s shares
plunged 45% after the South Korean bank desisted from its plans. The following day Lehman
announced an additional loss of $ 3.9 billion and their intent to sell off a majority stake in their
investment-management business. Lehman was frantically searching for a buyer as its shares
tumbeled another 40% on Thursday September 11, which was the day also of the ‘electronic run’
on the U.S. banking system that nearly bled America to death. The outflows threatened the stabi-
lity of the short-term funding markets, particularly the commercial paper market upon which
corporations rely heavily for their short-term borrowing needs.

To stem the tide, the Federal Reserve decided to temporarily close down the Money Market mu-
tual funds, which are specialised in highly liquid assets, like the parking of money in the inter-
banc circuit, of which Lehman was a part. Until then, these kind of funds were considered virtu-
ally risk-free. If the Fed had not acted, their estimation was that early in the afternoon 5.5 trillion
dollars would have been drawn out of the money market system of the United States, which by
one stroke would have collapsed the entire economy of the country, and together with it the world
economy. It was in this setting that on Saturday the Federal Reserve Bank called an emergency
meeting on the future of Lehman. On Monday, Lehman announced it would file for Chapter 11
bankruptcy protection, citing debts of $ 768 billion and assets worth $639 billion. That day the
Dow Jones stock index lost more than 500 points and for the first time in more than 26 months
closed down below the 11,000 level. It was the largest single day drop since the Twin Towers
debâcle seven years earlier. And then, on October 2, 2008, the index started to crash. On the 3rd
trading day it broke through the 10,000 level and on the 6th it closed at 8,579, representing an
aggregate loss of more than 20%, while the calender year loss until then was more than 35%.
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4 - Greenspan foiled regulatory efforts, but the real culprit hides elsewhere
Shortly after Brooksley E. Born was named to head the Commodity Futures Trading Commission
(CFTC) in 1996, she was invited to lunch by Federal Reserve chairman Alan Greenspan. He star-
ted the conversation by saying: “Well, Brooksley, I guess you and I will never agree about
fraud.” “What is there not to agree on?” Born says, she replied. “Well, you probably will always
believe there should be laws against fraud, and I don’t think there is any need for a law against
fraud”, she recalls. Greenspan evidently believed the market would take care of itself. For the
incoming regulator, the meeting was a wake-up call. “That underscored to me how absolutist
Alan was in his opposition to any regulation”, she said in an interview by Rick Schmitt.

Over the next three years, Born would learn first-hand the potency of those absolutist views,
confronting Greenspan and other powerful figures in the capital over how to regulate Wall Street.
In the beginning of 2009, as analysts sorted out the origins of what became the worst financial
crisis since the Great Depression, Born emerged as a sort of modern-day Cassandra. Some people
believe the debâcle could have been averted or muted had Greenspan and others followed her
advice.
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As chairperson of the CFTC, Born advocated reining in the huge and growing market for finan-
cial derivatives. (Derivative instruments are instruments which derive their value from the value
and characteristics of one or more underlying assets.) These instruments started out as ways for
large corporations and banks to manage their risk exposure across a range of investments. One
type – known as a credit-default swap – has been a key contributor to the economy’s unraveling
in the wake of the Lehman debâcle. Ultimately, Greenspan and the other regulators foiled Born’s
efforts, and Congress took the extraordinary step of enacting legislation that prohibited her agen-
cy from taking any action, a very unfortunate development. Being put at the sideline, Born de-
cided to leave government and return to her private law practice in Washington. (Source: “Pro-
phet and Loss” by Rick Schmitt, Stanford Magazine - March/April 2009)

Yet, the real culprit in the debâcle has been the extraordinary liquidity created by the electronic
tradings systems. This kind of liquidity creates the danger of extreme and lightning fast swings.
Liquidity nowadays allows to buy and sell marketable securities and to transfer huge amounts of
money in the blink of an eye. Essentially it creates the means to create money out of assets with-
out going through time consuming procedures, as was still the case during the October 1987
crash. The instituted ‘brakes’ to stop trading for a certain period if the stockmarket falls too much,
is a way to curb liquidity, but once the brakes are taken off, the liquidity is fully restored. These
brakes have some merit, but, as the experience in the morning of September 11 2008 shows, did
not play a part. In my view the present market liquidity constitutes the risk of a meltdown of the
world financial markets – a case which is much worse than a crash. Understand me well, I adore
liquidity, I think it’s fantastic and a source of never-ending satisfaction. And many would agree.
For one thing: liquidity will stay and only improve due the increasing speed and volumes of
electronic data handling and the development of ever more sophisticated algorithms that are
designed to trade within split seconds, and much faster than the human mind can think.