Is Shadow Banking Really Banking?
I just wanted to pass along a nice paper here from the St Louis Fed on shadow banking. You’ve probably heard a lot about shadow banking over the years and this nicely summarizes the role of shadow banking, why it came to be and how it works.
“The term “shadow banking” has been attributed to 2007 remarks by economist and money manager Paul McCulley to describe a large segment of financial intermediation that is routed outside the balance sheets of regulated commercial banks and other depository institutions. Shadow banks are defined as financial intermediaries that conduct functions of banking “without access to central bank liquidity or public sector credit guarantees.” 1 As shown in Figure 1, the size of the shadow banking sector was close to $20 trillion at its peak and shrank to about $15 trillion last year, making it at least as big as, if not bigger than, the traditional banking system.2 Given its size and role in the financial crisis, it would be useful to understand the mechanics of shadow banking. To do so, some basics of traditional banking need to be understood first.”
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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Thanks for Tweeting/posting this. The actual STL Fed piece is very good.
Starting at the output end with the investor, they have short term money to invest. Their short term money is traded for a security. The security is funneled to them in sequence first by the SPV, then to administrator and then to underwriter. The underwriter trades their “created” security for the short term money held by the investor.
The SPV (Special purpose vehicle) is a department under the aggregator and usually is part of a TBTF bank. The SPV is where the security is created.
Starting at the input end with our Commercial Banks: We the unwitting sheeple take out a new housing loan. Commercial bank passes our housing loan documents to the Aggregator, who passes it to the SPV. This is where the magic happens. The SPV slices and dices our loans and assigns risk. In effect they take our Federally Insured secured housing documents, and turn them into a financial vehicle – the security. Whenever there is “risk assignment” there is room for fraud, and everybody knows TBTF banks committed fraud by tranching high and low risk “loans” together. In effect, the aggregator trades short term “Investor” money for our housing loans.
Short term money (e.g.mutual funds,etc.) wants to find a secure location to park, and it finds the offered security – where said security is based on our housing loans. Short term money is traded for long term money. In effect we are trading our mutual fund and 401K short term money for our long term mortgage money. Money comes out of one of our pockets and then goes into another, while the “banker” takes a slice for himself.
This is a savings and loan scheme, where short term money loans long. It is not banking. The FEDs defense is pathetic. It’s really pathetic and they must think we are all morons because it’s too difficult to follow the shell game.
Additional fraud is baked into the cake, because commercial banks do liar loans, NINJA loans, etc. Why? – Because it doesn’t matter to them… the commercial bank doesn’t have to think about risk. Commercial banks trade-out their junk mortgages to the Aggregator at the speed of light. The Aggregator in turn trades out their short term money formerly from the investor to buy our loans.
It is a scam to slice out interest arbitrage between short term and long term money. Does risk assignment at the SPV take into account that short term money that can vaporize in an instant? Also, the robo signing scandal was probably due to this scam as well, where the Investor wanted additional security e.g. possession of our housing loans that ultimately backed up the security.
The article you written was graphically very attractive. i got some useful information about shadow banking. thanks for being with us.