Jamie Dimon 2008 Letter to Shareholders: III. Fundamental Causes and Contributions to the Financial Crisis
I believe there are four structural risks or imbalances that grew and coalesced to cause a “run on the bank.” But this was not a traditional bank run – it was a run on our capital markets, the likes of which we had never experienced. After Lehman’s bankruptcy, many parts of our capital markets system stopped providing any capital to the market at all. If the crisis had unfolded differently, then perhaps the events that followed would not have occurred. Surely no one deliberately built a system with these fundamental flaws and imbalances. Clearer heads will understand that much of this was not malfeasance – our world had changed a lot and in ways that we didn’t understand the full potential risk. But when the panic started, it was too much for the system to bear.
In essence, too much longer-term, non-investment grade product was converted into shorter-term Triple A-rated product. Some banks, hedge funds, SIVs and CDOs were using short-term financing to support illiquid, long-term assets. When the markets froze, these entities were unable to get short-term financing. As a result, they were forced to sell these illiquid assets. One of the functions of banking and the capital markets is to intermediate between the needs of investors and issuers. This triggers a normal conversion, either directly or indirectly (through securitizations) of longer-term, illiquid assets held by the issuers, who need to finance the business into the shorter-term, higher-grade product that most investors want. Clearly, over time, this imbalance had grown too large and unsupportable.
Money market funds promise to pay back 100% to the investor on demand. Many money market funds invested in 30- to-180-day commercial paper or asset-backed securities that under typical circumstances could be sold back at par. In normal times, investors demanded their money in fairly predictable ways, and funds were able to meet their demands. Over time, money market funds grew dramatically to exceed $4 trillion. After Lehman collapsed, one money fund in particular, which held a lot of Lehman paper, was unable to meet the withdrawal demands. As word of that situation spread, investors in many funds responded by demanding their money. In a two-week period, investors pulled $500 billion from many money funds, which were forced to sell assets aggressively. To raise liquidity, these money funds essentially were forced to sell assets. As investors moved away from credit funds and into government funds, the banks simply were unable to make up the difference. This became one more huge rupture in the dike.
Over time, in those markets where financial companies financed their liquid assets, financial terms had become too lax. For example, to buy non-agency mortgage securities, financial institutions only had to put up 2%-5% versus a more traditional 15%-25%. The repo markets also had begun to finance fairly esoteric securities, and when things got scary, they simply stopped doing so. In the two weeks after Lehman’s bankruptcy, more than $200 billion was removed from this type of financing, by both investors and banks. Once again, financial institutions had to liquidate securities to pay back short-term borrowing – thus, another rupture in the dike.
Individual investors, corporations, pension plans, bond and loan funds, money market funds and others – all acted in their own self-interest, and all individually acted wisely. But collectively, they caused enormous flows out of the banking and credit system. Regardless of whether the funds came out of a bank, a money fund, or a bond or loan fund, the fact remains that the cumulative result was a severe shortage of necessary credit that was removed from the system.
Clearly, things had changed. In the past, regulators had focused on preventing a systemic collapse of the main intermediaries in the financial system; i.e., the banks. In this new world, however, we need to discuss how to protect ourselves not only from runs on banks but also from runs on other critical vehicles in the capital and financial markets.
