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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
short-term, safe securities such as Treasury bonds and highly rated corporate debt,
and the funds paid higher interest rates than banks and thrifts were allowed to pay.
The funds functioned like bank accounts, although with a different mechanism: cus-
tomers bought shares redeemable daily at a stable value. In , Merrill Lynch in-
troduced something even more like a bank account: “cash management accounts”
allowed customers to write checks. Other money market mutual funds quickly
followed.
These funds differed from bank and thrift deposits in one important respect: they
were not protected by FDIC deposit insurance. Nevertheless, consumers liked the
higher interest rates, and the stature of the funds’ sponsors reassured them. The fund
sponsors implicitly promised to maintain the full net asset value of a share. The
funds would not “break the buck,” in Wall Street terms. Even without FDIC insur-
ance, then, depositors considered these funds almost as safe as deposits in a bank or
thrift. Business boomed, and so was born a key player in the shadow banking indus-
try, the less-regulated market for capital that was growing up beside the traditional
banking system. Assets in money market mutual funds jumped from billion in
to more than billion in and . trillion by .
To maintain their edge over the insured banks and thrifts, the money market
funds needed safe, high-quality assets to invest in, and they quickly developed an ap-
petite for two booming markets: the “commercial paper” and “repo” markets.
Through these instruments, Merrill Lynch, Morgan Stanley, and other Wall Street in-
vestment banks could broker and provide (for a fee) short-term financing to large
corporations. Commercial paper was unsecured corporate debt—meaning that it was
backed not by a pledge of collateral but only by the corporation’s promise to pay.
These loans were cheaper because they were short-term—for less than nine months,
sometimes as short as two weeks and, eventually, as short as one day; the borrowers
usually “rolled them over” when the loan came due, and then again and again. Be-
cause only financially stable corporations were able to issue commercial paper, it was
considered a very safe investment; companies such as General Electric and IBM, in-
vestors believed, would always be good for the money. Corporations had been issuing
commercial paper to raise money since the beginning of the century, but the practice
grew much more popular in the s.
This market, though, underwent a crisis that demonstrated that capital markets,
too, were vulnerable to runs. Yet that crisis actually strengthened the market. In ,
the Penn Central Transportation Company, the sixth-largest nonfinancial corpora-
tion in the U.S., filed for bankruptcy with million in commercial paper out-
standing. The railroad’s default caused investors to worry about the broader
commercial paper market; holders of that paper—the lenders—refused to roll over
their loans to other corporate borrowers. The commercial paper market virtually
shut down. In response, the Federal Reserve supported the commercial banks with
almost million in emergency loans and with interest rate cuts. The Fed’s ac-
tions enabled the banks, in turn, to lend to corporations so that they could pay off
their commercial paper. After the Penn Central crisis, the issuers of commercial pa-
per—the borrowers—typically set up standby lines of credit with major banks to en-
