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shadow banking market

Page history last edited by Brian D Butler 1 year, 5 months ago

 

 

 

What is the "Shadow Banking"?

 

money market funds

hedge funds

private equity

derivatives

structured finance

securitization of mortgages

 

“shadow banking system”, comprising hedge funds, broker-dealers, private equity funds, structured investment vehicles and conduits and money market funds. This shadow banking system was typically highly leveraged, and had an extensive nexus with the banking system. However, the shadow banking system suffered much lighter regulation. This “regulatory arbitrage” encouraged loose practices, hunt for quick yields and non-transparent and risky financial products.

 

Table of Contents:


 

 

Graphic Map of Shadow Banking system:

 

 

London:

 

Think of the various less-than-transparent actors that have set up shop in London

– Many sovereign wealth funds.

– A lot of the SIVs set up by US (and European) banks were legally domiciled in the UK

– Some credit hedge funds

- And most importantly, a host of European banks with large dollar books (think of them as badly regulated credit hedge funds) ran a large part of the dollar exposure through London.

 

There was a reason, after all, why residents in the UK were the largest purchaser of US corporate debt over the past few years. Corporate debt – in the US balance of payments data – includes asset-backed securities. Foreign purchases of such debt soared – especially from 2004 to 2007 – before falling off a cliff during the crisis.

 

 

Derivatives - Market Size

 

what are "derivatives"?...see here:  derivatives

 

Market Size: HUGE: 

see data here:  http://www.bis.org/statistics/otcder/dt1920a.pdf

 

Notional amounts outstanding:  June'08 = $683,725 billion

Gross market values:                             =   $20,353 billion   (approx $21 Trillion USD!!)

 

Derivatives bubble explodes five times bigger in five years. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007, then to $683 trillion by June '08.   How big is that?   A comparison...To grasp how significant this five-fold bubble increase is, let's put that $516 trillion in the context of some other domestic and international monetary data:

 

  • U.S. annual gross domestic product is about $15 trillion
  • U.S. money supply is also about $15 trillion
  • Current proposed U.S. federal budget is $3 trillion
  • U.S. government's maximum legal debt is $9 trillion
  • U.S. mutual fund companies manage about $12 trillion
  • World's GDPs for all nations is approximately $50 trillion
  • Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
  • Total value of the world's real estate is estimated at about $75 trillion
  • Total value of world's stock and bond markets is more than $100 trillion
  • BIS valuation of world's derivatives back in 2002 was about $100 trillion
  • BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion
 
Notional  vs Gross
 
  • "Notionl" value is the "maximum losses in case of a meltdown" ....and gives an idicator of the market's size
  • "gross market values" tells you the scale of financial risk transfer taking place in derivatives markets."

 

 

Leverage:

because they are unregulated, leverage is higher...as explained in this simple graph from Pimco (money manager).  Less reserves acting as the foundation of the pyramid of promises. 

 

 

 

 

Definition:  (from Wikipedia)

 

The shadow banking system or the shadow financial system consists of non-bank financial institutions that, like banks, borrow short, and in liquid forms, and lend or invest long in less liquid assets[1]. They are able to do this via the use of credit derivative instruments which allow them to evade normal banking regulations, e.g. those related to specifying ratios of capital reserves to debt. Many "shadow bank" like institutions and vehicles have emerged in American and European markets, between the years 2000 and 2008, and have come to play an important role in providing credit across the global financial system.[2]

The system includes SIVs, conduits, money market funds, monolines, investment banks, hedge funds and other non-bank financial institutions. These institutions are subject to market risk, credit risk and especially liquidity risk, since their liabilities are short-term while their assets are more long term and illiquid. This creates a potential problem in that they are not depositary institutions and do not have direct or indirect access to their central bank's lender-of-last-resort support. Therefore, during periods of market illiquidity, they could go bankrupt if unable to refinance their short-term liabilities.[3]  Until the summer of 2007, structured investment vehicles (SIVs) and collateralised debt obligations (CDOs) attracted little outside attention and were not always fully recognized on the balance sheets of their affiliated banks. Since then the shadow banking system has been blamed[2] for aggravating the subprime mortgage crisis and helping to transform it into a global credit crunch.[4]  The term "shadow banking system" is attributed to Paul McCulley of PIMCO by PIMCO's CEO Bill Gross[5].

 

 

Shadow Banking & Credit Crisis 2007-09:

 

hedge funds, investment banks, and structured financial conduits – have been forced to delever as government funds have been directed to more visible institutional lenders.

 

Securitization has for several years exceeded bank loans as a percentage of private credit market debt. In contrast to recent headlines, however, banks have been picking up their lending, but it has been the “shadow banks” that have faltered. read more here:  http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/IO+Feb+2009+Gross+Beep+Beep.htm

 

 

Banks have been recapitalized – yes – and banks have cautiously started to lend. But shadow banks are still delevering due to disappearing and unavailable fresh capital and, as they do, they continue to drag asset prices with them.

 

 

 

 

 

The shadow banking system with its leverage and financial innovation, powered a near 25-year global economic expansion, but it is the delevering of those hidden quasi-banks that is now threatening i

 

PIMCO’s Ramin Toloui has produced Chart 2 which correlates the contraction in household debt to the decline of the securitization market. He estimates that there is a one trillion dollar hole that needs to be filled by policymakers in this area alone.

 

while new loans can be and are being advanced via the banking system, it’s a much more difficult task to force shadow banks to lend. That lending depends on securitization which in turn depends on stable and eventually higher asset prices than currently exist

 

read more:  http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/IO+Feb+2009+Gross+Beep+Beep.htm#

 

 

 

Why securitization is important (at reasonable rates):

 

see securitization of mortgages

 

"CMBS or (commercial real estate mortgage-backed securities) are now priced to yield over 12% vs. 5% in recent years. As real estate financing comes due and rolls over in the next few years, it is imperative these yields return to mid-single digits if shopping centers, retail malls, and office buildings are to remain viable."

 

Credit Crisis 07-09

 

what is the role that the "shadow banking" sector played in the crisis? 

 

 

Can you fix the problem without also addressing the Shadow banking sector?

no.

 

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Links

 

 

 

 

 

 

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