THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 241

CHAPTER 9

Montreal Accord. Under the Montreal
Accord, investors agreed to a standstill
period (initially 60 days, to October 16, 2007,
extended three times to February 22, 2008),
with the objective of restructuring the frozen
ABCP into long-term floating rate notes with
maturities matching the maturities of the
underlying assets in the conduits. However,
the agreement had to be renegotiated again
16 months later, in December 2008, with the
participation of the federal government and

High-Profile
Firms Fail

Financial Crises and the Subprime Meltdown 209

three provinces (Ontario, Quebec, and
Alberta), where publicly owned institutions
held over $20 billion of frozen non-banksponsored ABCP. Small investors (holding
less than $1 million of the paper) were fully
paid out in cash by the brokerage firms that
had sold them the paper, whereas the larger
investors were given bonds. The final cost of
the ABCP restructuring was in excess of
$200 million in fees, with the big investors
footing the bill.

In March of 2008, Bear Stearns, the fifth-largest investment bank in the U.S., which

had invested heavily in subprime-related securities, had a run on its funding and
was forced to sell itself to J.P. Morgan for less than 5% of what it was worth just a
year earlier. In order to broker the deal, the Federal Reserve had to take over
US$30 billion of Bear Stearns hard-to-value assets. In July, Fannie Mae and Freddie
Mac, the two privately owned government-sponsored enterprises that together
insured over US$5 trillion of mortgages or mortgage-backed assets, had to be
propped up by the U.S. Treasury and the Federal Reserve after suffering substantial losses from their holdings of subprime securities. In early September 2008 they
were then put into conservatorship (in effect run by the government).
Worse events were still to come. On Monday, September 15, 2008, after suffering losses in the subprime market, Lehman Brothers, the fourth-largest U.S.
investment bank by asset size (with over $600 billion in assets and 25 000 employees), filed for bankruptcy, making it the largest bankruptcy filing in U.S. history.
The day before, Merrill Lynch, the third-largest investment bank (which also suffered large losses on its holding of subprime securities), announced its sale to
Bank of America for a price 60% below its price a year earlier. On Tuesday,
September 16, AIG, an insurance giant with assets over US$1 trillion, suffered an
extreme liquidity crisis when its credit rating was downgraded. It had written over
US$400 billion of insurance contracts called credit default swaps that had to make
payouts on possible losses from subprime mortgage securities. The Federal
Reserve then stepped in with a US$85 billion loan to keep AIG afloat (later
increased to US$150 billion).
Also on September 16, as a result of its losses from exposure to Lehman
Brothers debt, the Reserve Primary Fund, a large money market mutual fund with
over US$60 billion of assets, broke the buck that is, it could no longer redeem
its shares at the par value of $1. A run on money market funds then ensued, with
the U.S. Treasury putting in place a temporary guarantee for all money market
mutual fund redemptions in order to stem withdrawals. On September 25, 2008,
Washington Mutual (WAMU), the sixth-largest bank in the United States with over
US$300 billion in assets, was put into receivership by the FDIC and sold to J.P.
Morgan, making it the largest bank failure in U.S. history.