The day one dollar per share became 97 cents

Tuesday, September 16, 2008, New York

The 3-cent announcement

Around 4 p.m. that day, an asset management company issued a one-page announcement. It stated that the Lehman Brothers bonds (face value $785 million) held by the Reserve Primary Fund, which it managed, would be valued at zero as of 4 p.m. that day. As a result, the price per share of the fund would become $0.97.

It was not the value of the dollar as a currency that fell. It was the price of one share in this fund. This means that a person who held one dollar's worth of shares saw their holding become 97 cents.

The Reserve Primary Fund was a mutual fund that invested the money it collected into short-term loans and was managed to maintain a share price of one dollar. This type of mutual fund is called a Money Market Fund (MMF). This fund, created in 1971, was the world's first MMF. A dissenting view included in the report of the Financial Crisis Inquiry Commission (FCIC) calls the breaking of the one-dollar-per-share mark a "critical psychological threshold" for MMFs, writing that it meant the money invested in the fund had actually decreased.

The announcement contained another rule: redemption requests received before 3 p.m. that day would be paid out at $1.00 per share. Those who withdrew early would get one dollar back, while those who remained would bear the loss.

However, the withdrawals did not begin with this announcement. Redemption requests had been piling up since the morning of the previous day, September 15, and the fund became unable to keep up with payments for the requests during that same day. And the financial crisis itself had begun more than a year before this day. The short-term money market first froze in August 2007. From September 16, 2008, when the crisis peaked, we will go back in time to trace the path that led to this day.

The loss was 3 cents per share. Nevertheless, within a week of this fund "breaking the buck," $349 billion was withdrawn from the entire category of funds known as prime MMFs. This was not just the amount from the Reserve Primary Fund. Why did 3 cents carry so much weight? First, let's look at the events in order, starting from the previous day.

Monday, September 15, 2008

The previous day, Lehman Brothers filed for bankruptcy

On Monday, the investment bank Lehman Brothers filed for Chapter 11 bankruptcy protection. The Lehman bonds held by the Reserve Primary Fund were a type of instrument issued when a company borrows money for a short period, known as commercial paper. The amount, $785 million, represented 1.2% of the fund's total assets of $62.4 billion.

That morning alone, redemption requests totaling $10.8 billion arrived. The fund's custodian bank (State Street) initially helped with payments through an overdraft facility, but stopped at 10:10 a.m. That day, the board of trustees valued the Lehman bonds at 80 cents on the dollar. The management company's executives had publicly promised to defend the one-dollar-per-share price. Nevertheless, from that day to the next, the 16th, another $29 billion in requests came in (up to this point, from the FCIC report).

Many of the times from this point forward are based on the complaint filed by the SEC in May 2009 against the management company and its executives. Please read this as the plaintiff's allegations, not as facts acknowledged by a court. According to the complaint, by around 5 p.m. on the 15th, requests exceeded $20 billion, and nearly half of that amount remained unpaid. Nevertheless, the management company continued to tell investors and the press that night that it would maintain the one-dollar-per-share price. However, the SEC alleges that no agreement was in place to support this.

The complaint continues regarding the 16th. As of 9 a.m., requests had reached approximately $24.6 billion, and only the first approximately $10.7 billion had been paid. The management company itself admitted in a November 26, 2008 announcement that from 11 a.m. to 4 p.m. on the 16th, the share price was $0.99, not $1.00. In the words of the complaint, the 4 p.m. announcement of 97 cents was issued without the management company realizing that the share price had already broken the buck several hours earlier.

The size of the loss was 1.2% of total assets. However, in a system where those who withdraw first lose less, it becomes advantageous to withdraw before the full extent of the loss is clear. The same logic as a bank run was at work in a mutual fund, which is not a bank.

This fund originally invested in conservative assets like government bonds and bank certificates of deposit. In March 2006, it told investors it would not invest in commercial paper. However, it changed its policy immediately afterward, and within 18 months, commercial paper grew from 0 to half of its assets. As yields rose, investors flocked in, and from 2006 to 2008, the fund's management group became the fastest-growing MMF manager in the United States. In the first eight months of 2008 alone, its size doubled.

The outcome of the lawsuit was reported by news agencies. In November 2012, a jury cleared the founder of the asset management company and his son of civil fraud charges. However, the son was found liable for negligence, and the company and other related firms were found liable on other counts. In 2013, in response to the SEC's request for over $130 million, a judge imposed penalties totaling $750,000: $100,000 on the son and $325,000 on each of the two companies (Reuters, October 1, 2013). So, why was Lehman unable to repay its short-term debt? To find the answer, we will go back a few years and look at home loans in the United States.

Going back in time: 2001–2007

Homebuyers' debt was increasing

In the 2000s in America, more and more people were borrowing money to buy homes. The average mortgage debt per household rose from $91,500 in 2001 to $149,500 in 2007.

Home prices also rose. The U.S. house price index (FHFA House Price Index, all transactions) rose annually from 299.98 in the first quarter of 2004, peaking at 380.31 in the first quarter of 2007.

The FCIC counts the collapse of mortgage lending standards as one of the causes of the crisis. It was not for lack of warnings. The FCIC's conclusion is that warnings about the surge in lending to borrowers with weak repayment capacity (subprime) and the unsustainable rise in housing prices were ignored.

Rating agencies assessed safety based on the premise that nationwide U.S. house prices had not fallen in the post-war period (Brunnermeier). Delinquencies began to increase in February 2007.

Same period (2000s): Where the loans went

Loans became a product traded worldwide

During the same period that home loans were increasing, the destination of these loans was also changing. Previously, banks typically held the loans they made on their own books until they were repaid. In this era, the practice of bundling and selling off loans instead of keeping them on their books, and then using that money to make new loans, became widespread. This was a shift from banks that "originate and hold" to banks that "originate and distribute."

The buyers were investment banks and others. They bundled many loans together, divided the right to receive monthly repayments into smaller portions, and sold them as investment products. Rating agencies assigned safety ratings to them, and investors around the world bought them.

The process of bundling rights to future cash flows, like from loans, dividing them into smaller pieces, and turning them into tradable products is called securitization. In this way, the risk that the loans might not be repaid was dispersed among investors worldwide who bought these securities. However, the investment banks that created them also held these securities themselves (see next chapter). It became difficult to see from the outside where these risks were located and how large they were.

The ratings later collapsed. Of the mortgage-backed securities rated AAA, the highest rating, in 2006, 83% were later downgraded. The FCIC concluded that this crisis would not have happened without the rating agencies.

2000–2007 How money was borrowed

Funding long-term assets with money refinanced daily

Investment banks not only created and sold loan securities, but also held them themselves. Much of the money for these was not their own, but borrowed. Moreover, much of this borrowing was very short-term, promised to be repaid the next day. The proportion of total assets funded by such overnight borrowing roughly doubled from 2000 to 2007.

This is how they borrowed: they would put up securities they held as collateral to borrow money, repay it the next day, and then borrow again. Formally, it is an agreement to sell a security and then buy it back on a specified date. This transaction is called a repo.

The five major investment banks, by one FCIC measure, held 40 units of assets for every 1 unit of their own money (capital). This meant that a drop of just under 3% in asset value would wipe out their own money. The ratio of assets held with borrowed funds to one's own money is called leverage.

The commercial paper held by the Reserve Primary Fund was also one of these short-term borrowings. MMFs were on the lending side, providing short-term money to investment banks and companies.

A staff paper from the Federal Reserve Bank of New York calls the collection of intermediaries that act like banks but cannot rely on deposit insurance or the central bank's lending window, such as MMFs, "shadow banking." Their liabilities were nearly $22 trillion in June 2007, exceeding the approximately $14 trillion of traditional banks.

August 2007–March 2008

When collateral is doubted, refinancing stops

The daily refinancing mechanism only works as long as the lender trusts the collateral. In a repo, the lender provides less money than the value of the collateral received. This deduction is to avoid losses if the collateral's value falls. This deducted percentage is called a haircut.

As mortgage delinquencies increased, the value of securities bundling these loans was no longer trusted. Lenders increased the haircut. From the borrower's perspective, this meant less money could be borrowed against the same collateral, and the shortfall had to be covered immediately.

For the average of 9 types of collateral other than government bonds, the haircut rose from 0.0% in the first half of 2007 to 3.9% in the second half, and to an average of 27.2% in 2008. Gorton and Metrick frame this as a run, an alternative to deposit withdrawals. Even though people were not lining up at teller windows, money was being pulled out.

Selling collateral to make up for the shortfall would cause prices to fall further, raising the haircut again. The ability to convert assets to cash or to borrow money when needed without causing a price collapse is called liquidity. In this crisis, liquidity was the first thing to be lost.

The first freeze occurred in August 2007. On August 9, the French bank BNP Paribas halted redemptions from three of its funds, and the European Central Bank and the Fed injected €95 billion and $24 billion, respectively, into the overnight market. Gorton and Metrick call this August the first systemic event.

In March 2008, the investment bank Bear Stearns was unable to obtain funding through repos. As seen in Figure 3, it was a company with large borrowings compared to its own capital. On Sunday, March 16, JPMorgan announced it would buy Bear Stearns for $2 a share, and the New York Fed lent $28.82 billion to take over Bear's assets.

The Reserve Primary Fund had also been lending to Bear Stearns via repos. In an interview with the FCIC, the fund's manager stated that they had continued lending until two days before the brink of collapse, and that after Bear was bailed out, they believed the government would rescue even larger investment banks if they got into trouble. The FCIC notes that this belief was shared by many other investment professionals. This expectation was proven wrong six months later, on September 15.

September 7–October 3, 2008

From September 7 to October 3

On September 7, the two mortgage finance companies, Fannie Mae and Freddie Mac, were placed under government conservatorship. On the 15th, Lehman filed for bankruptcy, and on the 16th, a share in the Reserve Primary Fund fell to 97 cents. On the evening of the same day, the 16th, the Fed decided to lend up to $85 billion to the insurance company AIG.

This brings us back to the initial question. The reason the 3 cents were so significant was not the size of the drop, but the chain of events that followed. First, withdrawals triggered more withdrawals. According to the FCIC, after this fund "broke the buck," the run spread even to MMFs that did not hold Lehman bonds. Even though disclosures showed they held no such bonds, investors withdrew their money for fear that other investors would withdraw first. In one week, $349 billion flowed out of the entire group of funds known as prime MMFs.

Second, the outflow dried up the short-term borrowing market. MMFs tried to sell the securities they held to generate cash for redemptions, but there were few buyers. The FCIC's investigation found that many major MMFs became unwilling to buy commercial paper from financial firms in the week after Lehman's collapse, and the five firms with the largest reductions halved their holdings from $58 billion to $29 billion. Interest rates on commercial paper rose unprecedentedly. Third, this affected the companies that borrowed in that market. Not only financial firms, but also general corporations that used commercial paper to cover immediate expenses like payroll and inventory payments found it difficult to borrow funds (FCIC Report, pp. 357–358).

The government and the central bank stepped in to replace the stalled flow of money. On September 19, the Treasury Department announced it would guarantee money market funds (MMFs) for one year for up to $50 billion from the Exchange Stabilization Fund, and the Fed established a facility to lend to banks that bought assets from MMFs. This facility lent $150 billion to banks in its first two weeks, and the two programs immediately slowed the run on MMFs (FCIC Report, p. 359). On October 3, the Emergency Economic Stabilization Act was passed, authorizing up to $700 billion to purchase troubled assets from financial institutions. On October 13, the Secretary of the Treasury summoned the heads of nine major firms to Washington and proposed a plan for the government to inject capital. All nine firms accepted. The next day, October 14, the Treasury announced the Capital Purchase Program to buy up to $250 billion in preferred stock from banks, and on October 28, it injected a total of $115 billion into eight of the nine firms (FCIC Report, pp. 373–374; Treasury report to Congress).

It is often said that not saving Lehman was the sole turning point. However, the run began in the summer of 2007 and peaked after Lehman's collapse (New York Fed paper). The FCIC's dissenting view lists the chain of events from September 7 to October 3, arguing that it is a mistake to attribute the panic solely to Lehman. Whether Lehman could or should have been saved remains an open question, even in the documents.

December 2007–October 2009, and beyond

Jobs and homes

Some companies financed their payroll and inventory payments with short-term borrowing called commercial paper (FCIC Report, p. 358). The turmoil in the financial markets in September had, through this channel, reached the point of affecting corporate payments and workers' salaries. However, the economic contraction had begun before September. The U.S. economy peaked in December 2007 and contracted for 18 months until the trough in June 2009 (NBER). The unemployment rate rose from 5.0% in December 2007 to 10.0% in October 2009, with 3.6 million jobs lost in 2008 and another 4.7 million by December 2009.

House prices continued to fall, with the FHFA House Price Index (All-Transactions) dropping by 19.0% from 380.31 in the first quarter of 2007 to 308.14 in the second quarter of 2012. The FCIC wrote that at the time of the report's printing, approximately 4 million households had lost their homes to foreclosure, and more than 26 million people were unemployed, underemployed, or had given up looking for work.

When we count who paid the price, three groups emerge. The first group consists of investors, borrowers, and financial institutions that suffered losses. In the case of the fund on September 16, those who withdrew their money early received the full amount, while those who remained bore the losses. Borrowers who lost their collateral and were forced to sell, and financial institutions whose capital was depleted, also fall into this category. The second group is the government. The support pledged by the government included over $180 billion to AIG, $151 billion to Fannie Mae and Freddie Mac by the third quarter of 2010, and a capital allocation of $125 billion to the nine major firms. The third group is the people who lost their jobs and homes.

Whether the government support ultimately resulted in a loss or a gain varied by program. For the AIG bailout, the Treasury and the Fed fully recovered the combined $182.3 billion they had committed by December 2012, and even made a profit of $22.7 billion ($5 billion for the Treasury, $17.7 billion for the Fed). For the entire TARP, which included capital injections into banks and housing support, all programs had ended by September 30, 2023. Of the $443.5 billion disbursed, the final cost was approximately $31.1 billion. Much of this was for assistance to protect homes from foreclosure (Treasury). The final profit or loss from the support for Fannie Mae and Freddie Mac cannot be determined from the sources cited here.

October 2008–2009 Japan

The impact reached Japan's exports and jobs

The crisis also reached Japan. According to preliminary trade statistics from the Ministry of Finance, Japan's export value in January 2009 decreased by 45.7% compared to the same month the previous year, and by 49.4% in February. In both months, the leading items in the decline were automobiles and electronic components such as semiconductors. For the full year of 2009, export value decreased by 33.1% from the previous year.

Gross Domestic Product (GDP) also contracted significantly. The first preliminary report on February 16, 2009, stated that real GDP for the October-December 2008 quarter decreased at an annualized rate of 12.7% from the previous quarter. GDP figures are revised multiple times later on. In the series published on September 8, 2026, the same quarter shows an annualized decrease of 9.2%. When reading GDP figures, it is necessary to check when the figures were published.

The impact also reached jobs. According to reports collected by the Ministry of Health, Labour and Welfare through local Labour Bureaus and Hello Work offices, the number of non-regular workers whose contracts were terminated or scheduled for termination between October 2008 and March 2009 was approximately 85,000 in 1,415 cases as of December 19, 2008. Of these, 57,300 (67.4%) were temporary agency workers. This was known as the "haken-giri" (dispatch-worker layoffs). A report as of September 18, 2009, extended the period to December 2009 and showed 238,752 people, of whom 141,619 (59.3%) were agency workers. These figures are based on voluntary surveys of business establishments and do not represent the total number of people who lost their jobs.

The Bank of Japan lowered its policy interest rate on October 31 and December 19, 2008, setting the target for the uncollateralized overnight call rate at around 0.1%.

Looking Back

No Single Cause

Tracing back from the day of the 97 cents, the sequence of events is as shown in the following diagram.

No single cause has been determined. It was a combination of lax lending standards, securitization, excessive borrowing, reliance on short-term funding, and inadequate regulation and supervision. The FCIC's majority opinion centered on failures in regulation and supervision, three commissioners listed 10 essential causes, stating that no single one was sufficient, and another commissioner cited government housing policy as a necessary condition.

What remains from this event is not an issue of price, but of where money is kept. Deposit insurance and the lender of last resort were created to protect bank deposits, but in 2007, much of the funding was outside this system. The Fed's mechanism for lending dollars through foreign central banks has become permanent and was used again in March 2020.