[Marxism-Thaxis] shadow banking system
(The Federal Reserve chart is available at _www.ny.frb.org/research/staff_reports/sr458.pdf_ (http://www.ny.frb.org/research/staff_reports/sr458.pdf) ) Road map that opens up shadow banking By Gillian Tett Financial Times November 18 2010 This week, a senior banker friend gave me a poster that had been created by downloading a chart recently produced by economists at the New York Federal Reserve. It was shocking stuff. Entitled The Shadow Banking System, the graphic depicts how money goes round the modern world, particularly (but not exclusively) in the US. At the top lies a smart section labelled the “Traditional Banking System”, in which a simple flow of boxes explains how investors’ funds are deposited with traditional commercial banks, which then transform this into long and short-term loans, and equity. So far, so comprehensible. But most of the poster is dominated by two sections called the “cash” and “synthetic” shadow banking systems, or those “ financial intermediaries that conduct maturity, credit and liquid transformation without access to central bank liquidity or public sector credit guarantees”, as the associated NY Fed working paper says. These flows are so extraordinarily complex that hundreds of boxes create a diagram comparable to the circuit board of a high-tech gadget. Even as poster size, it is difficult to decode. But it should be mandatory reading for bankers, regulators, politicians and investors today. Indeed, they might do well to hang similar posters next to their desks, for at least three reasons. For one thing, this circuit board is a reminder of how clueless most investors, regulators and rating agencies were before 2007 about finance. After all, during the credit boom, there was plenty of research being conducted into the financial world; but I never saw anything remotely comparable to this road map. That was a striking, terrible omission. The Fed now estimates that in early 2008 shadow banking was $20,000bn in size, dwarfing the $11,000bn traditional banking system. And though this shadow system has now shrunk to a “mere” $16,000bn, this remains bigger than traditional banking, at some $13,000bn. Little wonder, then, that so few people immediately appreciated the significance of the seizing up of shadow banking in 2007. But secondly, this poster is also a reminder that many things about the modern financial system remain mysterious – even today. On the edges of the circuit board, the NY Fed economists list all the government programmes that have supported the system since 2007 (and, in effect, replaced shadow banks when they suffered runs). This “shadow, shadow bank system” – as it might be called – looks complex and baffling too. And in practical terms, the sheer breadth and complexity of that box makes it hard to know what will happen if – or when – government aid disappears. Then, there is the current regulatory debate. So far this year, the Financial Stability Board and other international bodies have focused most of their reform attention on issues such as bank capital, and systems of oversight for large, systemically important banks. Next year, though, Mario Draghi, head of the FSB, wants to start discussing the shadow banking world. Many national regulators are keen to do this too as they recognise the danger of looking at regulation just in terms of institutions. After all, the crisis has shown how risky it is to have $16,000bn worth of maturity transformation without any backstop, or clear rules. This week, for example, Adair Turner, head of the Financial Services Authority, the UK regulator, promised more scrutiny. Earlier this year Paul Tucker, deputy UK central bank governor, suggested that it was time to see which parts of the system were benign – or not. The US government is now considering whether to extend the regulatory umbrella to large, non-bank institutions such as Citadel or GE Capital. But whether this desire for a debate turns into sensible reform remains unclear. For getting politicians to focus on the issue may not be easy in 2011. There is already considerable regulatory fatigue. There are also other, more urgent distractions, such as the sovereign debt crises. And shadow banking issues rarely seem “sexy” in political terms, unless they involve hedge funds (which pose less systemic threat than, say, the vast $3,000bn-odd money market fund sector.) So for my money, the best thing the NY Fed could do right now is print thousands of copies of that poster – and dispatch it across the world. I suspect it would be far more persuasive about the need for debate than any number of pious G20 speeches. After all, a key reason why that circuit board became so complex was that bankers were trying to arbitrage the last two sets of Basel rules. If shadow banking continues to be ignored (ie politicians focus just
[Marxism-Thaxis] "shadow banking system" unravelling
(Shadow banking system = new non-banking financial architecture?) _http://www.ft.com/cms/s/0/622acc9e-87f1-11dd-b114-779fd18c.html?nclick_ch eck=1_ (http://www.ft.com/cms/s/0/622acc9e-87f1-11dd-b114-779fd18c.html?nclick_check=1) The shadow banking system is unraveling By Nouriel Roubini Published: September 21 2008 17:57 | Last updated: September 21 2008 17:57 Last week saw the demise of the shadow banking system that has been created over the past 20 years. Because of a greater regulation of banks, most financial intermediation in the past two decades has grown within this shadow system whose members are broker-dealers, hedge funds, private equity groups, structured investment vehicles and conduits, money market funds and non-bank mortgage lenders. Like banks, most members of this system borrow very short-term and in liquid ways, are more highly leveraged than banks (the exception being money market funds) and lend and invest into more illiquid and long-term instruments. Like banks, they carry the risk that an otherwise solvent but liquid institution may be subject to a selffulfilling and destructive run on its liquid liabilities. But unlike banks, which are sheltered from the risk of a run – via deposit insurance and central banks’ lender-of-last-resort liquidity – most members of the shadow system did not have access to these firewalls that prevent runs. A generalised run on these shadow banks started when the deleveraging after the asset bubble bust led to uncertainty about which institutions were solvent. The first stage was the collapse of the entire SIVs/conduits system once investors realised the toxicity of its investments and its very short-term funding seized up. The next step was the run on the big US broker-dealers: first Bear Stearns lost its liquidity in days. The Federal Reserve then extended its lender-of-last-resort support to systemically important broker-dealers. But even this did not prevent a run on the other broker-dealers given concerns about solvency: it was the turn of Lehman Brothers to collapse. Merrill Lynch would have faced the same fate had it not been sold. The pressure moved to Morgan Stanley and Goldman Sachs: both would be well advised to merge – like Merrill – with a large bank that has a stable base of insured deposits. The third stage was the collapse of other leveraged institutions that were both illiquid and most likely insolvent given their reckless lending: Fannie Mae and Freddie Mac, AIG and more than 300 mortgage lenders. The fourth stage was panic in the money markets. Funds were competing aggressively for assets and, in order to provide higher returns to attract investors, some of them invested in illiquid instruments. Once these investments went bust, panic ensued among investors, leading to a massive run on such funds. This would have been disastrous; so, in another radical departure, the US extended deposit insurance to the funds. The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years. Even private equity firms and their reckless, highly leveraged buy-outs will not be spared. The private equity bubble led to more than $1,000bn of LBOs that should never have occurred. The run on these LBOs is slowed by the existence of “convenant-lite” clauses, which do not include traditional default triggers, and “payment-in-kind toggles”, which allow borrowers to defer cash interest payments and accrue more debt, but these only delay the eventual refinancing crisis and will make uglier the bankruptcy that will follow. Even the largest LBOs, such as GMAC and Chrysler, are now at risk. We are observing an accelerated run on the shadow banking system that is leading to its unravelling. If lender-of-last-resort support and deposit insurance are extended to more of its members, these institutions will have to be regulated like banks, to avoid moral hazard. Of course this severe financial crisis is also taking its toll on traditional banks: hundreds are insolvent and will have to close. The real economic side of this financial crisis will be a severe US recession. Financial contagion, the strong euro, falling US imports, the bursting of European housing bubbles, high oil prices and a hawkish European Central Bank will lead to a recession in the eurozone, the UK and most advanced economies. European financial institutions are at risk of sharp losses because of the toxic US securitised products sold to them; the massive increase in
