How the money-market rescue operation worked

By Felix Salmon
August 24, 2011

Bloomberg has got its hands on new data from the Fed, and it’s looking a bit desperate in its attempt to squeeze news out of that data. Its latest scoop, under the headline “Fed Made State Street Profitable as Middleman”, starts like this:

State Street Corp. (STT) and JPMorgan Chase & Co. (JPM) profited during the financial crisis by borrowing $200 billion almost risk-free from the Federal Reserve under a program intended to rescue money-market mutual funds.

What on earth does it mean to borrow money “almost risk-free”? There’s risk involved in lending money, of course. But I have no idea what risk-free borrowing might be. On top of that, the profits here seem incredibly modest. The Fed lent State Street $89 billion; State Street then took that money and bought various securities from money-market funds. It held those securities to maturity, and ended up making a profit of $75.6 million.

That’s a return of 0.08%.

It’s hard to get too worked up about this: the Fed needed to do something about money-market funds; it was legally incapable of conducting this operation itself; and therefore it got State Street and JP Morgan to help set up the program, paying them a modest 8bp fee for doing so. Bloomberg tries to find an expert of some description to get outraged about this, but the best they can do is to find a finance professor who thinks the fee was “appropriate”:

“The program was enacted without any bidding process and awarded on the basis of whoever was there at the moment,” said Joseph R. Mason, a finance professor at Louisiana State University in Baton Rouge. While the banks’ return may have been appropriate, the lack of competitive bids is troubling, Mason said. He noted that for State Street, JPMorgan and other participants, “there was virtually no risk.”

That’s true — but you can be sure that if there was risk involved, State Street and JP Morgan would have charged much more than 0.08%. It’s also worth noting that the Fed itself made much greater profits on the program than the banks did: some $543 million in total.

State Street didn’t get its $75 million for nothing. For one thing, it helped to design and set up the program. And it also took the risk that it could end up buying debt which wasn’t indemnified by the Fed and which might end up defaulting. There’s operational risk in all of these schemes, especially when they’re set up in a hurry and have to get implemented in the middle of a financial crisis.

And the Bloomberg headline is I think a bit misleading: the way I read it, at least, it’s saying that the Fed program was responsible for making State Street profitable. That’s not true. In fact, it’s just saying that State Street’s role as a middleman was profitable. Which is true, but hardly news: if a bank can’t make money by acting as a middleman, then it won’t act as a middleman.

The big picture, here, is not that the State Street program made money, but that the program to rescue money-market funds worked. Many of these funds faced enormous redemption requests in the days after the Reserve fund broke the buck; thanks to this program, all of them managed to meet those requests. Ultimately what happened was that hundreds of millions of dollars which would normally have gone to depositors in money market funds went instead to the Fed, with State Street and a few other banks taking a small slice. The funds were saved, the Fed made a handy profit, and the system didn’t collapse. Sounds like a big success to me, rather than any kind of scandal.

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