Thursday, November 13, 2008

Soros: Commerial Paper was proximate cause / transition mechanism

... of inter-bank freeze. In his testimony, he doesn't address other linkages (derivatives, etc.), sweeping them into 'uncertainty' and parts not central to his basic thesis or description of the contagion.

A large money market fund that had invested in commercial paper issued by Lehman Brothers "broke the buck," i.e., its asset value fell below the dollar amount deposited, breaking an implicit promise that deposits in such funds are totally safe and liquid. This started a run on money market funds and the funds stopped buying commercial paper. Since they were the largest buyers, the commercial paper market ceased to function. The issuers of commercial paper were forced to draw down their credit lines, bringing interbank lending to a standstill. Credit spreads-i.e., the risk premium over and above the riskless rate of interest-widened to unprecedented levels and eventually the stock market was also overwhelmed by panic. All this happened in the space of a week.

Lo pegs 'uncertainty' to transparency, indicating that lack of understanding of why Lehman (and others) failed may have contributed to paralyzing uncertainty.'s a lot of reading to do. More later.

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