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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“it was legally incapable of conducting this operation itself;”

Can you expand on this? What was the legal prohibition of the Fed doing this directly with the money market funds?

Posted by m.jed | Report as abusive

“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.”

Yes, and the Fed’s PNFT (Profits Not From Treasury) is somewhere around, what, -$200B??

Posted by klhoughton | Report as abusive


The Fed’s site on the program references part 3 of section 13 here: d/section13.htm

Have fun trying to figure the law on unusual and exigent circumstances out. The basic gist seems to be that there are a lot of restrictions for the Fed’s lending in unusual and exigent circumstances, i.e. that procedures are in place to protect against lending to insolvent banks. So they couldn’t go to money market funds directly, but instead go to two banks with good balance sheets.

Posted by mwwaters | Report as abusive

What do you think the rate would have been had there been a competitive bidding process?

Posted by absinthe | Report as abusive

I think that this was one of the most necessary, but with relatively low moral hazard, operations in the crisis. The Fed provided liquidity to a market that desparately needed it while it was clear that the vast majority of the securities in the money market funds were still fine and would pay out 100 cents on the dollar. It was a classic run on the bank and the Fed provided the back stop.

Money market funds that turned out to have unexpected wrinkles were sued and so there is less liekly to be hanky-panky with these funds down the road, although the temptation to grab for yield is still huge because of ZIRP.

Posted by ErnieD | Report as abusive

nbywardslog, would worry about the Bloomberg “data”, it was mostly nonsense anyway and i would be worrying about Chinese banks not EU ones.

Posted by Danny_Black | Report as abusive

ErnieD nailed it…

The Bloomberg headline should have been something like:

Investigation shows Fed acted quickly with dubious legal authority or proper planning… and got it pretty much exactly right.

The MMMF’s the fed rescued had a liquidity problem not a solvency problem.

The best part of the whole story is that MMMF’s have been hugely regulated post crisis. The result is that the whole business is actually shrinking. There just isn’t any money to be made by the customers or the providers.

Posted by y2kurtus | Report as abusive

And the bigger story is that the government looked the other way as money market funds became as systematically and socially important as savings accounts. There is a scandal, in that the Fed was forced to put something together at the last minute, instead of relying on some sort of deposit insurance. The fact that it worked out fine this time is cause for relief, but not celebration.

Posted by AngryInCali | Report as abusive