As Credit Crisis Spiraled, Alarm Led to Action - Morningbull

who traded stocks or bonds with the firms. As federal officials had predicted,
that turned out to be manageable. (That was one reason the government did
not step in to save the firm.)
The real problem was that a handful of hedge funds that used the firm’s
London office to handle their trades had billions of dollars in balances
frozen in the bankruptcy.
Diamondback Capital Management, for instance, a $3 billion hedge fund,
told its investors that 14.9 percent of its assets were locked up in the
Lehman bankruptcy — money it could not extract. A number of other hedge
funds were in the same predicament. (When called for comment,
Diamondback officials did not respond.)
As this news spread, every other hedge fund manager had to worry about
whether the balances they had at other Wall Street firms might suffer a
similar fate. And Morgan Stanley and Goldman Sachs were the two biggest
firms left that served this back-office role. That is why Mr. Ackman’s
investors were calling him. And that is what caused hedge funds to pull
money out of Morgan Stanley and Goldman Sachs, hedge their exposure by
buying credit-default swaps that would cover losses if either firm couldn’t
pay money they owed — or do both.
It was fear, not greed, that was driving everyone’s actions.
Breaking the Buck
There was another piece of bad news spooking investors — and government
officials. On Tuesday, the Reserve Primary Fund, a $64 billion money
market fund, and two smaller, related funds, revealed that they had “broken
the buck” and would pay investors no more than 97 cents on the dollar.
Money market funds serve a critical role in greasing the wheels of
commerce. They use investors’ money to make short-term loans, known as
commercial paper, to big corporations like General Motors, I.B.M. and
Microsoft. Commercial paper is attractive to money market funds because it
pays them a higher interest rate than, say, United States Treasury bills, but
is still considered relatively safe.