State Street profited as Fed middleman

Boston bank loaned $89b during ’08 crisis

State Street collected a return of $75.6 million by borrowing almost-risk free from a Fed program. State Street collected a return of $75.6 million by borrowing almost-risk free from a Fed program. (Michael Fein/Bloomberg News/File 2009)
By Christopher Condon
Bloomberg News / August 24, 2011

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State Street Corp. and JPMorgan Chase & Co. profited during the financial crisis by borrowing $200 billion almost risk-free from the Federal Reserve under a program intended to rescue money-market mutual funds.

The Fed lent State Street a total of $89 billion to buy securities from the funds in 2008 and 2009 after the credit crisis triggered by the collapse of Lehman Brothers Holdings Inc., according to Fed data compiled by Bloomberg News from information released in response to Freedom of Information Act requests, related court orders, and an act of Congress. The central bank also guaranteed against losses on the short-term notes as long as they met eligibility guidelines.

State Street, based in Boston, held the securities to maturity and collected a return of $75.6 million, according to regulatory filings. JPMorgan borrowed and bought $111 billion in securities under the same program, records show. While New York- based JPMorgan hasn’t disclosed its profit from the transactions, it would have been about $93 million at the same rate of return State Street reported.

“The program was enacted without any bidding process and awarded on the basis of whoever was there at the moment,’’ said Joseph R. Mason, a finance professor at Louisiana State University. While the banks’ return may have been appropriate, the lack of competitive bids is troubling, Mason said. He noted that for State Street, JPMorgan, and other participants, “there was virtually no risk.’’

The gains came from a Fed program called the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or AMLF. It was designed to inject cash into money funds that faced increasing redemption pressures as global credit markets seized up after Lehman’s Sept. 15, 2008, bankruptcy. State Street, JPMorgan Chase and others acted as middlemen, collecting profit as they funneled the central bank’s cash to the funds.

AMLF was unique among Fed emergency programs that provided a peak of $1.2 trillion in crisis-era aid in that it offered private-sector intermediaries a chance for gains. The program opened six days after the Sept. 16, 2008, collapse of the $62.5 billion Reserve Primary Fund, which set off a stampede by investors from money funds. By helping other funds meet their redemptions, AMLF prevented additional failures that would have deepened the crisis, Fed officials say.

The Fed used banks as middlemen under the $217 billion program because the central bank is prohibited from directly purchasing the securities the funds had to sell.

It got around that rule without using intermediaries when it opened the Commercial Paper Funding Facility on Oct. 27, 2008. In that program, the Federal Reserve Bank of New York funded a special-purpose vehicle to purchase short- term debt directly from issuers. The vehicle earned the Fed $6.1 billion in interest income over the life of the program, according to the Fed’s Office of Inspector General.

With AMLF, there was no time for creating a similar entity, and the central bank wanted to ensure that banks didn’t hesitate to participate, said William Nelson, deputy director in the Fed Board’s Division of Monetary Affairs.

State Street worked closely with the Fed in setting up the program, Carolyn Cichon, a company spokeswoman, said in an e- mail. The bank was among AMLF’s first participants “for our clients wishing to utilize the facility,’’ she said.