THE HEALTHY RUN ON THE WHOLESALE MONEY MARKET—INTERRUPTED In fact, as the financial meltdown gathered momentum after Lehman failed on September 15, Goldman, and especially Morgan Stanley, became the victims of a violent "run on the bank" by wholesale lenders, which in classic fashion lost confidence in the value of their collateral. Yet that "run," so much deplored by Washington officialdom, was actually a good thing— the market's mechanism for flushing out the bad assets that had piled up on Wall Street balance sheets.
Under the circumstances, these firms had no choice but to rapidly liquidate assets, even at fire sale losses, in order to generate cash to redeem the short-term funding which was coming due in a great tidal wave. Such was their just desert for engaging in the age-old folly of borrowing short and hot, and investing long and illiquid.
Had economic nature been allowed to take its course, the resulting massive destruction of capital value at the two remaining investment banks would have been profoundly therapeutic. It would have demonstrated conclusively that the combined $500 billion of long-term debt and equity capital which had been issued by Goldman and Morgan Stanley over the previous decades had been vastly overvalued and was far more vulnerable to catastrophic loss than the trend-following money managers who owned it had understood.
While the financial party fueled by the Fed's interest rate repression and "put" under risk assets roared, the Wall Street business model thrived: issuance of overvalued debt and equity enabled it to scalp gargantuan profits from balance sheets bloated with cheap wholesale money. The speculative mania on Wall Street was thus well and truly fostered in the misguided conference rooms of the Fed's Eccles Building.
When the crash came, however, the inflated prices of the Goldman and Morgan Stanley equity and bonds had come under withering attack. The fund managers who owned them should have suffered massive losses, been fired by their firms, and become an example for an entire generation of money managers, steeling them for years to come against another Wall Street swindle of such hazardous aspect.
But Paulson and Bernanke body-checked the free market before the grim reaper could complete its appointed rounds. So doing, they gave credence to the lame whining of Wall Street executives who claimed they were victims of nefarious short-sellers. But that was pettifoggery. They were actually the victims of just plain sellers: investors and traders who had belatedly recognized that the capital securities of these giant hedge funds would be soon swamped in a tidal wave of losses.
Absent Washington's bailout interventions, Goldman's stock price would likely have proven to be worth far less than its $60 book value, if anything at all. Certainly it would not have been worth even close to the ballyhooed "bargain price" of $115 per share paid by Warren Buffet (only after Uncle Sam pitched a safety net under the market) or the $250 per share it had reached during the bubble peak.
As it turned out, Washington's intervention with TARP and the Fed alphabet soup of liquidity programs stopped the wholesale bank run in its tracks. It accomplished this by the very simple expedient of replacing the hundreds of billions of private wholesale funding—short-term commercial paper and overnight repo funding—which had gone into hiding with freshly minted Federal Reserve credit. And it was this instant, cheap funding do-over which was the ultimate evil of the bailouts.
In truth, the "run" in the wholesale funding market was the market's homemade remedy for purging the speculative fevers which had overtaken Wall Street. At the time of the meltdown, the evaporation of wholesale funding was a curative agent, forcing Goldman, Morgan Stanley, and other leveraged hedge funds, including those such as Lehman and Merrill Lynch which had already been rendered insolvent, to liquidate their vast inventories of toxic assets at prices far below book value.