Fed Made State Street Profitable as Money-Fund Middleman in ’08
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.
The Fed lent State Street a total of $89 billion to buy securities from the funds in 2008 and 2009 after the credit crisis triggered by the collapse of Lehman Brothers Holdings Inc., according to Fed data compiled by Bloomberg News from information released in response to Freedom of Information Act requests, related court orders and an act of Congress. The central bank also guaranteed against losses on the short-term notes as long as they met eligibility guidelines.
State Street, based in Boston, held the securities to maturity and collected a return of $75.6 million, according to regulatory filings. JPMorgan borrowed and bought $111 billion in securities under the same program, records show. While New York- based JPMorgan hasn’t disclosed its profit from the transactions, it would have been about $93 million at the same rate of return State Street reported.
“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.”
The gains came from a Fed program with a complicated name and a simple concept: the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or AMLF. It was designed to inject cash into money funds that faced increasing redemption pressures as global credit markets seized up after Lehman’s Sept. 15, 2008, bankruptcy. State Street, JPMorgan Chase and others acted as middlemen, collecting profit as they funneled the central bank’s cash to the funds.
(View the Bloomberg interactive graphic to chart the Fed’s financial bailout.)
AMLF was unique among Fed emergency programs that provided a peak of $1.2 trillion in crisis-era aid in that it offered private-sector intermediaries a chance for gains. The program opened six days after the Sept. 16, 2008, collapse of the $62.5 billion Reserve Primary Fund, which set off a stampede by investors from money funds. By helping other funds meet their redemptions, AMLF prevented additional failures that would have deepened the crisis, Fed officials say.
The Fed used banks as middlemen under the $217 billion program because the central bank is prohibited from directly purchasing the securities the funds had to sell.
It got around that rule without using intermediaries when it opened the Commercial Paper Funding Facility on Oct. 27, 2008. In that program, the Federal Reserve Bank of New York formed and funded a special-purpose vehicle to purchase short- term debt directly from issuers. The vehicle earned the central bank $6.1 billion in interest income over the life of the program, according to the Fed’s Office of Inspector General.
With AMLF, there was no time for creating a similar entity, and the central bank wanted to ensure that banks didn’t hesitate to participate, said William Nelson, deputy director in the Fed Board’s Division of Monetary Affairs.
“We were responding to a national emergency at that point,” Nelson said. “Had we implemented the program with less attractive terms, we would have risked falling short in our effort to stop the run on money-market mutual funds and seeing a far worse financial crisis.”
Nelson said the central bank earned “an appropriate return on all the loans.” The AMLF program, which charged the central bank’s discount rate on loans, produced $543 million in interest income, according to the Fed’s inspector general. The rate varied from 2.25 percent when the program began to as low as 0.5 percent by January 2009. The last AMLF loan, given in May 2009, matured in August 2009.
State Street worked closely with the Fed in setting up the program, Carolyn Cichon, a company spokeswoman, said in an e- mail. The bank was among AMLF’s first participants “for our clients wishing to utilize the facility,” she said.
State Street is the third-largest U.S. custody bank. It keeps records, tracks performance and provides other support services for institutional investors that include money-market funds. Its participation in AMLF explains why it ranked fifth on Bloomberg’s list of biggest borrowers from multiple Fed programs, with a peak of $77.8 billion on Oct. 1, 2008. First was New York-based Morgan Stanley with peak borrowings of $107.3 billion. It was followed by Citigroup Inc. (C) at $99.5 billion and Bank of America Corp. (BAC) at $91.4 billion.
Tapped Other Programs
While AMLF funds accounted for most of State Street’s Fed borrowings during the financial crisis, the bank also tapped other emergency programs for liquidity. Its loans from the Term Auction Facility and the Commercial Paper Funding Facility peaked at a combined $18.5 billion on March 31, 2009, after the firm’s excess liquidity plunged by 44 percent in the first three months of that year.
State Street was hurt during the crisis both by losses on its own investments and on investments made for clients. The firm wrote down the value of its bond portfolio by $3.7 billion in May 2009. It also paid out at least $830 million in penalties to regulators and compensation to clients who lost money in funds that invested in mortgage-backed securities.
State Street slashed its quarterly dividend in February 2008 to 1 cent a share from 24 cents. It remained at 1 cent until rising to 18 cents in March 2011.
JPMorgan is the second-largest custody bank behind Bank of New York Mellon Corp. (BK) Howard Opinsky, a spokesman for JPMorgan, declined to comment. Its borrowings from AMLF peaked at $61.9 billion on Oct. 2, 2008, according to Fed data. The bank’s overall borrowings from seven Fed programs peaked at $68.6 billion, ranking it eighth on Bloomberg’s list of top borrowers.
While BNY Mellon, Bank of America, Citigroup, SunTrust Banks Inc. (STI) and Credit Suisse Group AG (CSGN) also participated in the AMLF program, JPMorgan and State Street handled 92 percent of the debt purchases the program financed.
David Skidmore, a Fed spokesman, said no banks that wished to participate in AMLF as intermediaries were turned away.
JPMorgan used $17.6 billion, or 16 percent of the total it handled, to purchase debt from money funds run by its own money- management unit, JPMorgan Funds, according to Fed data. BNY Mellon used 89 percent of its $12.9 billion in loans to buy debt from money funds in its Dreyfus unit, the data show. Ron Gruendl, a spokesman for BNY Mellon in New York, declined to comment.
‘Breaking the Buck’
AMLF opened for business after investors withdrew $230 billion from money funds in the four days after Lehman’s failure. Their withdrawals were accelerated when losses on Lehman debt caused Reserve Primary to drop below $1 a share, an event known as “breaking the buck” that has proved fatal the two times it occurred.
Other funds faced the prospect of having to sell assets at a loss to meet redemptions. Because such funds are the largest collective buyer in the commercial-paper market, their sudden liquidity squeeze also threatened the ability of U.S. companies to sell short-term debt. AMLF helped ease the crisis by lending banks the money to purchase the commercial paper at amortized cost -- the level at which the funds valued the notes -- from the funds that most needed cash.
“AMLF was critical in restoring liquidity and confidence to the commercial-paper market,” Brian Reid, chief economist of the Investment Company Institute, a Washington-based trade group for the funds industry, said in an e-mail. “Money-market funds turned from net sellers of commercial paper into net buyers after the Fed launched the program.”
Only asset-backed debt issued by a U.S.-based borrower with maturities shorter than 120 days for bank holding companies and 270 days for depository institutions was eligible for the program. The securities were also required to carry a rating of at least A1, P1 or F1, the highest ratings for short-term debt, without a “negative watch” designation. The debt could be purchased only from funds experiencing net redemptions exceeding 5 percent of assets in a single day, or 10 percent over 5 consecutive business days.
James Nolan, head of supervision, regulation and credit at the Federal Reserve Bank of Boston, which administered AMLF, said the requirements created at least some risk for banks. Those that chose to participate operated under tight deadlines to ensure the paper they bought complied. They’d have borne any losses on non-qualifying debt, Nolan said.
Outside Normal Business
“We were asking them to do something their normal business doesn’t require them to do, and to assume the risk of loss if they failed to comply with the program requirements,” he said.
Nathan Flanders, managing director of the fund and asset management ratings group at Fitch Ratings in New York, called the task of meeting the Fed’s restrictions “straightforward.”
“It wasn’t without cost, but it had more to do with operational instead of economic risk,” he said.
None of the debt purchased under the program suffered any losses.
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