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What were you having for lunch when the whole world almost crashed and burned on September 18?

I was having the Beijing Beef and fried rice at Panda.

Just in case you thought things are bad, they could have been much worse.

Here is Capital Markets Subcommittee Chair, Rep. Paul Kanjorski (Pa), on C-SPAN talking about the bailout. The money quote (literally) comes at about two and half minutes into the video when he describes Ben Bernanke talking about a $550 billion — that’s $550 BILLION — drawdown of U.S. money market accounts in one hour on September 18. That’s nearly equal to 80% of the TARP bailout money Treasury would ask for just two days later.

Money quote from the video:

On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that 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.

If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S., would have collapsed the entire economy of the U.S., and within 24 hours the world economy would have collapsed. It would have been the end of our economic system and our political system as we know it.

Ummm, this is the first I’ve heard of this.

And I read practically every paper on the planet every day.

Not surprisingly, mainstream news outlets aren’t rushing to pick this one up. Is Kanjorski lying just a little bit? Or is this a little window into “what they know” behind closed doors?

Well, here’s what was going on the week of September 18. After the break, of course.

Monday, September 15
After a frenzied weekend stage-managed by Henry Paulson and Tim Geithner, Bank of America agrees to purchase at firesale prices the investment bank Merrill Lynch, which is on the verge of imminent bankruptcy.

Monday, September 15
Lehman Brothers, another investment bank, files for Chapter 11 bankruptcy shortly after midnight on Monday morning.

Monday, September 15
Henry Paulson declares the U.S. banking system “sound.”*

Tuesday, September 16
The Fed bails out AIG, also on the verge of sudden bankruptcy, with $85 billion in loans.

Tuesday, September 16
Because of the Lehman bankruptcy filing, the value of the Lehman debt securities (mostly IOU’s) held by the Reserve Primary Fund, one of the largest money market funds, plunges from $785 million to exactly 0, pushing the per-share value of the Reserve Primary Fund to below one dollar, something always regarded as unthinkable. Reserve immediately announces that it will not honor share redemptions made after 3 PM, September 16 until seven days later, the maximum allowed by law. Other large money market funds, such as Fidelity, rush to the cameras to say they have no Lehman debt securities on their books.

Here is USA Today on September 16 reporting on Reserve Primary Fund’s drop in value to below one dollar:

Money market funds have long feared that if they broke the buck, thereby shrinking investors’ principal, people would shift their money into bank money market accounts or ultrasafe Treasury securities. The question now is whether other money funds will follow the Reserve fund in dipping below $1.

The total value of money held in money market funds totals around $3.5 trillion on September 16.

Thursday, September 18
According to Rep. Kanjorski, there’s a massive run on money market funds and the whole house of financial cards nearly comes down bringing civilization as we know it down with it.

Thursday, September 18
Henry Paulson, who only three days previously had described the banking system as “sound,” President Bush holds a news conference in which he says emergency legislation must be “moved urgently.”

Friday, September 19
The Fed rolls out the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) offering loans at the primary credit rate to U.S. banks to help finance the purchase of high-quality asset-backed securities from money market mutual funds.

Friday, September 19
The Treasury Department offers $50 billion from the Exchange Stabilization Fund guarantying money market mutual fund investments will not drop below $1.

Friday, September 19
The SEC temporarily bans short-selling of 799 financial industry stocks in what it calls “an emergency action.”

Saturday, September 20
The Treasury Department unveils a plan to buy up troubled assets from banks, the plan that would eventually become TARP. The new fund will not buy up any “troubled” assets purchased after September 17.

Looking at the events of that fateful week, Kanjorski’s story not only looks plausible, it explains the sudden panic on September 18 that led to emergency meetings and the largest federal intervention in the financial system since the New Deal. The press at the time blamed the panic on the Lehman bankruptcy, but Kanjorski’s we’re-all-going-to-die story about September 18 makes the flurry of activity Thursday evening and Friday morning much more sensible.

Here’s what probably happened. The Fed and Treasury decided to let Lehman go for a variety of reasons. On Tuesday, Primary Reserve Fund had to mark down its Lehman debt to zero and broke the one dollar mark on its share price, thus wiping out the seemingly sacrosanct value of the investor’s principal. Then, sometime on Thursday, this markdown triggered automated redemptions of money market funds by large institutions around the globe — many folks doing the withdrawals probably weren’t aware of it, explaining why half a trillion dollars “disappeared” from money market funds in a little over an hour. Had the Fed not stopped the drawdowns, the full scale of the potential automated redemptions will probably never be known. Remember, only $3.5 trillion were in U.S. money market funds, not $5.5 trillion. It is still, however, an unimaginably high number (what’s a few trillion among friends, eh?), so Kanjorski’s overall story arc seems correct. If this automated run on money market funds had continued, the financial system around the globe would have collapsed, though “end our political system as we know it” seems to have a margin of error of a billion or so.

In response, the government moved quickly to protect the funds. The Fed stopped the redemptions and the very next day both the Fed and Treasury moved quickly to guarantee the funds (stopping the automated redemptions). The money market drawdowns were a rude wake-up call the Paulson-Fed team that had allowed Lehman to go belly-up.

Put in this perspective, the flurry of measures taken Thursday and Friday night (the AMLF, the loans from the Treasury, and TARP) were, it seems, crafted in great haste and unutterable panic, which was the typical operating mode of Bush Administration decision-making. This explains the amount of money Paulson was looking for ($700 billion), why he wanted it to have no oversight (because he feared an imminent collapse and wanted the authority to inject money wherever the dam might burst — remember, $550 billion waltzed out of the money market funds in just one hour), why it was so unformed (3 pages), and why so much of the money was used to capitalize healthy banks (because one of the most ready sources of capital, which had locked up, for banks was relatively liquid holdings in money market funds). This also explains why whenever Paulson was questioned about TARP months after the money had been distributed, he consistently answered that the only purpose of the funds was to prevent a total collapse of the financial system. He should know. He had front row seats on September 18 to the members-only show.

This also helps explain John McCain’s ham-handed suspension of his campaign on Wednesday, September 24. Both McCain and Obama were being regularly briefed by Henry Paulson, so both would have had balcony seats for the money market meltdown on Thursday, September 18. The common reaction, even from the right, to McCain’s campaign suspension was that it was cynical and self-serving. To his credit (or shame), it may have been a genuine reaction to the crisis, since McCain knew better than we did how close we were dancing to the precipice. Seen in this light, McCain panicked (in much the same way Paulson was panicking all the way to Sunday when he got on his knees and begged Nancy Pelosi to get TARP passed in the House). In his panic, McCain inserted himself in a process he didn’t really understand, while Obama simply sat back and let the pros do their job. However you paint McCain’s reaction, had he known that the financial system nearly collapsed after a run on U.S. money market funds, his campaign suspension seems more like a genuine response rather than a cynical ploy.

So the timeline seems to bear out the truth of Kanjorski’s story (though I think the $5.5 trillion number is wrong). And, yes, this is another case of “you can’t handle the truth.”

*Paulson’s exact words when he described the banking system as sound were: “We’re working through a difficult period in our financial markets right now as we work off some of the past excesses, but the American people can remain confident in the soundness and the resilience of our financial system.”

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