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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
repo lenders refused to lend as they had in the case of Bear Stearns, but it did not pro-
tect against clearing banks’ refusing exposure to an investment bank during the day.
On July , Fed officials circulated a plan, ultimately never implemented, that ad-
dressed the possibility that one of the two clearing banks would become unwilling or
unable to unwind its trades. The plan would allow the Fed to provide troubled in-
vestment banks, such as Lehman Brothers, with billion in tri-party repo financ-
ing during the day—essentially covering for JP Morgan or BNY Mellon if the two
clearing banks would not or could not provide that level of financing. Fed officials
made a case for the proposal in an internal memo: “Should a dealer lose the confi-
dence of its investors or clearing bank, their efforts to pull away from providing
credit could be disastrous for the firm and also cast widespread doubt about the in-
strument as a nearly risk free, liquid overnight investment.”
But the New York Fed’s new plan shouldn’t be necessary as long as the PDCF was
there to back up the overnight lenders, argued Patrick Parkinson, then deputy direc-
tor of the Federal Reserve Board’s Division of Research and Statistics. “We should tell
[JP Morgan] that with the PDCF in place refusing to unwind is unnecessary and
would be unforgiveable,” he emailed Dudley and others.
A week later, on July , Parkinson wrote to Fed Governor Kevin Warsh and Fed
General Counsel Scott Alvarez that JP Morgan, because of its clearing role, was
“likely to be the first to realize that the money funds and other investors that provide
tri-party financing to [Lehman Brothers] are pulling back significantly.” Parkinson
described the chain-reaction scenario, in which a clearing bank’s refusal to unwind
would lead to a widespread fire sale and market panic. “Fear of these consequences is,
of course, why we facilitated Bear’s acquisition by JPMC,” he said.
Still, it was possible that the PDCF could prove insufficient to dissuade JP Morgan
from refusing to unwind Lehman’s repos, Parkinson said. Because a large portion of
Lehman’s collateral was ineligible to be funded by the PDCF, and because Lehman
could fail during the day (before the repos were settled), JP Morgan still faced signifi-
cant risks. Parkinson noted that even if the Fed lent as much as billion to
Lehman, the sum might not be enough to ensure the firm’s survival in the absence of
an acquirer: if the stigma associated with PDCF borrowing caused other funding
counterparties to stop providing funding to Lehman, the company would fail.
THE FED AND THE SEC: “WEAK LIQUIDITY POSITION”
Among the four remaining investment banks, one key measure of liquidity risk was
the portion of total liabilities that the firms funded through the repo market: to
for Lehman and Merrill Lynch, to for Morgan Stanley, and about
for Goldman Sachs. Another metric was the reliance on overnight repo (which ma-
ture in one day) or open repo (which can be terminated at any time). Despite efforts
among the investment banks to reduce the portion of their repo financing that was
overnight or open, the ratio of overnight and open repo funding to total repo fund-
ing still exceeded for all but Goldman Sachs. Comparing the period between
March and May to the period between July and August, Lehman’s percentage fell
