Lehman’s collapse: The money fund “ice-nine wasn’t noticed… at first’”

Bloomberg News is writing a very worthy series of retrospective articles on the financial panic of September 2008.  I profiled the first one on Monday.  The next in the series came out yesterday and it makes for riveting and enlightening reading.

Bloomberg News reporters Bob Ivry, Mark Pittman and Christine Harper talked to a large number of market participants to get a sense of what happened in the financial system to bring the global economy to its knees, not just at Lehman but throughout the system. Their analysis hits on the money markets as a catalyst for the market meltdown.

Mohammed El-Erian has the money quote with a nice reference to Kurt Vonnegut and Cat’s Cradle by the Bloomberg team.

The ice-nine wasn’t noticed by most market participants at first, said Mohamed El-Erian, chief executive officer of Newport Beach, California-based Pacific Investment Management Co., the world’s largest fixed-income fund manager.

“Monday and Tuesday, people didn’t quite see what was happening,” El-Erian said in a July interview. “You had to be on the desk in the payments and settlements system, cash and collateral, to start seeing cascading market failures and a complete erosion of trust.”

What was this ice-nine doomsday agent?  The commercial paper and money markets – not credit default swaps or the intra-bank market. But, this market NEVER came up in the pre-Lehman collapse crisis meetings.

It was commercial paper and the $3.6 trillion money market industry that traded the notes that came close to sinking the global economy — not a breakdown in credit-default swaps or bank-to-bank lending. The bankers were focused on saving themselves, and commercial paper, as invisible as the air they breathed, never came up at the meetings, according to one of the two dozen executives invited to the New York Fed by its president, Timothy F. Geithner, 48, and Paulson.

The reason no one cared or even thought about the money markets is that no one from those areas or from operations and clearing was at the table when the crisis was being discussed.  How many Wall Street CEOs worked in operations or settlements? Zero. What was striking about the financial crisis is how little high level bankers knew about how the financial system really functioned.

And to this day, nothing is being done about the $3.6 trillion money markets.  Paul Volcker, one of America’s most respected bankers, said a full two weeks ago that regulation of money market funds was necessary and that these funds weaken the U.S. financial system.  Have you heard anything about this?

Of course not. Bankers hate this idea. As the Volcker article says:

“Paul Volcker has a 30-year hatred of money funds and he is woefully behind the times,” Federated Investors Inc. Executive Vice President Eugene F. Maloney, whose Pittsburgh-based company is the third-largest money-fund manager, said in a telephone interview.

So, don’t hold your breath waiting for any legislation on this issue.

More from Bloomberg on the Panic of 2008 here.