Web Extra: Read an Excerpt of David Stockman's New Book

The workout in the commercial banking sector, therefore, has turned out to be a slow-motion write-down, not a red-hot meltdown of the type which afflicted Wall Street. There was no basis for a retail bank run and never would have been one in the absence of TARP.

This outcome was readily ascertainable in September 2008, by means of a cursory examination of the collective balance sheet of the nation's non–Wall Street banking system. There was absolutely no reason for panic about the financial "contagion" spreading to Main Street banks. Nor was there any excuse for suspending the normal rules which required the FDIC to close failed banks and to completely wipe out debt and equity security holders.

THE URBAN LEGEND OF SKIPPED PAYROLLS AND DARK ATMS Another false vector of the contagion story centered on the panic in the money market mutual fund sector and the resulting drastic shrinkage of the commercial paper market. It was from this chain of events that the urban legend arose about ATMs going dark and business payrolls being skipped. In truth, the commercial paper market had become a giant bubble and needed to be cut down to size, but the implication that this necessary unwind had brought the payments system to the verge of collapse was not even remotely accurate.

In fact, after Congress courageously voted down the first TARP bill, the orchestrators of the bailout, Chairman Bernanke and Secretary Paulson, cynically deployed these payments freeze horror stories to spook congressmen and other policymakers into falling in line. As Senator Mel Martinez recalled their pitch, "I just remember thinking, you know, Armageddon . . . if these guys in the middle of it . . . believe this to be as dark as they are painting it, it must be pretty darned dark."

Senator Martinez's recollections reveal the true contagion: it was the contagion of fear which two panic-stricken men, Bernanke and Paulson, spread through the nation's capital like wildfire during the hours after the Lehman failure. Yet nothing like the financial nuclear meltdown alleged by Washington officialdom ever occurred or threatened.

The heart of the false panic was rooted in the money market mutual fund sector. Total short-term deposits at the time of the crisis had reached a big number: $3.8 trillion. So an honest-to-goodness "run" by investors would have been scary indeed. It turns out, however, that the "run" amounted to little more than a circular movement of cash among different money market fund types, with virtually zero impact on the Main Street economy.

As it happened, roughly $1.9 trillion, or half of total money market deposits, were held in a category of fund which invested exclusively in US Treasury and agency debt or tax-exempt muni bonds. During the entire period of the Wall Street crisis, this "governments only" segment of the money market fund industry experienced no losses or investor liquidations whatsoever.

By contrast, the other $1.9 trillion was in "prime" funds. In addition to investing in safe government securities and bank CDs, the prime funds were also permitted to hold commercial paper, thereby slightly enhancing interest rate yields compared to purely government funds.

During the several weeks after the Lehman failure about $430 billion, or slightly less than 25 percent of deposits, fled the "prime" fund half of the industry. This flight was triggered when the largest and oldest of these funds, the Reserve Prime Fund, announced that it "broke the buck" owing to the fact that about $750 million of its $60 billion in assets had been invested in Lehman commercial paper. Yet obscured in the hubbub was the fact that the resulting losses were tiny—just 3 percent of assets. In reality, breaking the buck was a money fund marketing pratfall, not the precursor to Armageddon; it amounted to a modest wake-up call disabusing investors of the industry's phony claim that money market accounts were absolutely safe and immune to loss.

So the unexpected shock from the Reserve Prime Fund's breaking the buck triggered a "run" on the prime funds of significant magnitude during the week or two after September 15. Yet according to the Financial Crisis Inquiry report, most of this so-called flight money did not get very far; that is, 85 percent, or $370 billion, of this outflow simply migrated to what were perceived to be safer "government only" money market funds.

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