Financial Institutions, Markets, and Money, Eleventh Edition

CHAPTER SEVEN

Money Markets

ON SEPTEMBER 13, 2008, Henry Paulson, U.S. Secretary of the Treasury, and Timothy Geithner, president of the Federal Reserve Bank of New York, called a meeting on the future of Lehman Brothers, an embattled investment bank plagued by large losses and eroding confidence of counterparties who became unwilling to lend funds to Lehman even for the shortest periods of time. Two dozen of the world's most powerful bankers brought together by Geithner and Paulson failed to devise a rescue plan for Lehman. Two of the most interested potential acquirers, Bank of America and a U.K.-based Barclays PLC backed out as federal regulators refused to provide any government support in the Lehman sale. On Monday, September 15, 2008, Lehman Brothers, a 158-year-old investment bank, filed for Chapter 11 bankruptcy protection.

Allowing a large financial institution to fail may cause a chain reaction that spreads panicky moods to other parts of the financial markets. Lehman's demise caused tremors throughout the financial system, especially in the money markets. Money markets are markets for short-term, often unsecured debt. When investors in the money markets lose confidence in potential borrowers, they stop lending and start hoarding cash. The stakes are simply too high to take risks. A business that does not have enough cash to meet its immediate needs (such as a bank not having enough cash to meet deposit withdrawals) may fail due to illiquidity, even if it is otherwise ...