When Prime Brokers Fail

From “Euphoric Episode” to Panic

The 2008 financial crisis wiped away the exultant mood that had dominated global financial markets for years. Not only did the collapse kill the market for mortgage-backed securities and other exotic securities, it also deflated the once-high-flying segments of private equity, leveraged buyouts, investment banking, and mergers and acquisitions. Among the most significant casualties were investment bank and prime broker Bear Stearns, which JPMorgan Chase rescued in March 2008, and mortgage guarantors Freddie Mac and Fannie Mae, which the US government took over that September.

But the spark that ignited the real panic came on Sept. 15, 2008, when Lehman Brothers, one of the world’s largest financial institutions, declared bankruptcy. Because of money market funds’ exposure to Lehman, they succumbed quickly; their net asset values (NAVs) dropped below the legally and symbolically important $1 standard. That led to a cascade of redemptions by institutional and retail investors. As the crisis unfolded, major banks disappeared, and big corporations such as General Motors, AIG and Chrysler suffered deep financial wounds. Hedge funds and ...