The Colorado Surplus Asset Fund Trust (CSAFE) has provided cash management services to local governments in Colorado since 1988. Today, the CSAFE team is proud of what has been, and even more excited for what is to come. You don’t have the opportunity to safeguard the funds of Colorado local governments for such a long time without being prepared for anything. It’s important to keep your surplus funds with an investment team that has the experience to navigate any storm. While money markets are typically calm, there have been pockets of choppy water in the past…
For those of us with gray in our hair who were managing public funds in September 2008, the memories of the day that came to be known as the “Lehman Shock” are likely quite clear. That said, the increasing number of public funds managers at Colorado local governments whose careers began after the Global Financial Crisis might appreciate the historical context even more than those who lived through it.
The Lehman Shock refers to the collapse of Lehman Brothers late on Sept. 15th, 2008, when the 158-year-old investment bank filed for bankruptcy. While Bear Stearns had been rescued earlier that year through a Fed-facilitated JPMorgan Chase acquisition at $2 per share, and AIG would receive an $85 billion bailout the day after Lehman’s collapse, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke chose to let Lehman Brothers fail.
The decision to let Lehman fail was driven by political concerns about moral hazard and taxpayer bailouts, as well as the belief that the financial system could absorb the shock. This calculation proved disastrously incorrect. Lehman’s collapse sent shockwaves through global financial markets, as the firm was deeply interconnected with other major financial institutions through complex derivatives. Lehman’s bankruptcy triggered a liquidity crisis that froze credit markets worldwide, contributed to a sharp decline in stock markets, and accelerated the broader financial crisis that would require unprecedented government intervention to resolve.
The impact on money market funds was severe, creating a crisis in what had traditionally been considered one of the safest asset classes. The Reserve Primary Fund, one of the nation’s oldest money market funds widely credited with pioneering the modern money market fund industry, “broke the buck” on Sept. 16, 2008—meaning its stable net asset value fell below $1.00 per share. This happened because the Reserve Primary Fund held $785 million in Lehman Brothers commercial paper, representing about 1.2% of its assets, which became worthless overnight following Lehman’s bankruptcy filing.
Like other local government investment pools (LGIPs) in Colorado, CSAFE maintained a liquidity position in the Reserve Primary Fund (RPF). Despite initiating its redemption from the RPF on the day of the Lehman Shock, CSAFE’s redemption was “gated” while redemptions by some other LGIPs were processed normally. This unequal treatment eventually resulted in substantial litigation—in fact, 20 lawsuits followed the RPF’s collapse, including both regulatory enforcement and private investor class actions—because the RPF provided a first-mover advantage to some shareholders and not others. This issue later became a central component of money market regulatory reforms.
The seven-day redemption gate imposed by the RPF affected many investors, including CSAFE. The Lehman Shock fundamentally altered the financial landscape, ultimately resulting in new regulations requiring greater diversification, enhanced disclosure requirements, and higher liquidity buffers (such as the daily and weekly liquidity requirements delineated in GASB 79, to which CSAFE’s Cash Fund adheres).
Alan Krcmarik, former CFO at the City of Loveland and the Chairman of the CSAFE Board of Trustees at the time, said, “It was an incredibly intense time for all involved—the Board, the service providers, and most importantly, the participants. We were fortunate to be working with professionals who burned the midnight oil to make sure our investors would come out unscathed following the events at Lehman and the Reserve Primary Fund. In fact, some of those folks are still involved with CSAFE today, and the participants can take comfort in knowing that there is a certain caliber of institutional knowledge and fiduciary vigilance stewarding their taxpayers’ dollars.”
Ultimately, not a single CSAFE participant lost principal as a result of the RPF’s inability to honor CSAFE’s redemption request. CSAFE did not “break the buck,” and throughout the tumultuous period that was the Lehman Shock and the Global Financial Crisis, CSAFE maintained its AAAm rating.
The events of September 2008 serve as a stark reminder of the importance of diversification—while risks such as the RPF and its position in Lehman Brothers are always apparent in hindsight, a critical aspect of public funds management that can be planned for in advance is maintaining prudent diversification among asset classes, including LGIPs.
CSAFE maintains the “local” in local government investment pool by working with firms that prioritize Colorado’s local governments, because Colorado’s taxpayers deserve nothing less. The CSAFE team will continue to direct its collective focus on remaining a sound, reliable cash management option for Colorado’s local governments and the constituents and stakeholders they serve.