Shadow Banking Makes a Comeback
Credit conditions are improving for speculators and bubblemakers, but they continue to worsen for households, consumers and small businesses. An article in the Wall Street Journal confirms that the Fed’s efforts to revive the so-called shadow banking system is showing signs of progress. Financial intermediaries have been taking advantage of low rates and easy terms to fund corporate bonds, stocks and mortgage-backed securities. Thus, the reflating of high-risk financial assets has resumed, thanks to the Fed’s crisis-engendering monetary policy and extraordinary rescue operations.
Here’s an excerpt from the Wall Street Journal:
"A new quarterly survey of lending by the Federal Reserve found that hedge funds and private-equity funds are getting better terms from lenders and that big banks have loosened lending standards generally in recent months. The survey, called the Senior Credit Officer Opinion Survey, focuses on wholesale credit markets, which the Fed said functioned better over the past quarter." ("Survey shows credit flows more freely", Sudeep Reddy, Wall Street Journal)
In contrast, bank lending and consumer loans continue to shrink at a rate of nearly 5 per cent per year. According to economist John Makin, there was a "sharp drop in credit growth, to a negative 9.7 per cent annual rate over the three months ending in May." Bottom line; the real economy is being strangled while unregulated shadow banks are re-leveraging their portfolios and skimming profits. Here’s more from the WSJ:
"Two-thirds of dealers said hedge funds in particular pushed harder for better rates and looser nonprice terms, and they said some of the funds got better deals as a result….(while) The funding market for key consumer loans remained under stress, with a quarter of dealers reporting that liquidity and functioning in the market had deteriorated in recent months." ("Survey shows credit flows more freely", Sudeep Reddy, Wall Street Journal)
As the policymaking arm of the nation’s biggest banks, the Fed’s job is to enhance the profit-generating activities of its constituents. That’s why Fed chair Ben Bernanke has worked tirelessly to restore the crisis-prone shadow banking system. As inequality grows and the depression deepens for working people, securitization and derivatives offer a viable way to increase earnings and drive up shares for financial institutions. The banks continue to post record profits even while the underlying economy is gripped by stagnation.
Central bank monetary policy is largely responsible for the worst financial crisis since the Great Depression. Low interest rates and an unwillingness to reign in over-leveraged banks and non-banks triggered a run on the shadow system that left many depository institutions insolvent. Eventually, the Fed was able to stop the bleeding by providing trillions of dollars in emergency relief and by issuing blanket government guarantees on complex bonds and securities that are currently worth roughly half of their original value. The Fed is now reconstructing this same system without any meaningful changes. The upward transfer of wealth continues as before.
The Federal Reserve Bank of New York’s own report confirms that securitization and massive leveraging contributes to systemic instability. Here’s an excerpt from the FRBNY’s "The Shadow Banking System: Implications for Financial Regulation":
"The current financial crisis has highlighted the growing importance of the “shadow banking system,” which grew out of the securitization of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States, but it has had a profound influence on the global financial system…..Securitization was intended as a way to transfer credit risk to those better able to absorb losses, but instead it increased the fragility of the entire financial system by allowing banks and other intermediaries to “leverage up” by buying one another’s securities." ("The Shadow Banking System: Implications for Financial Regulation", Tobias Adrian and Hyun Song Shin, Federal Reserve Bank of New York)
The former President of FRBNY, William Dudley, made similar comments in a recent speech. He said, "This crisis was caused by the rapid growth of the so-called shadow banking system over the past few decades and its remarkable collapse over the past two years.”
The system can be fixed by imposing capital and liquidity requirements on shadow banks and by maintaining strict underwriting standards on loans. Regulators need additional powers to check up on institutions which presently operate outside their purview. Any institution that poses a risk to the rest of the system must be regulated by the state. Unfortunately, the Fed opposes such changes because they threaten the profit-margins of its constituents. The Fed is paving the way for another catastrophe.
Securitization creates strong incentives for fraud. Prior to the Lehman Bros. default, structured securities, like bundled loans, were in great demand because investors were looking for Triple-A bonds with higher yields than US Treasuries and CDs. Bogus ratings convinced investors that mortgage-backed securities, asset-backed securities, and collateralized debt obligations were "risk free" when, in fact, many of the loans were made to applicants who had no ability to repay their debts. As foreclosures soared, financial intermediaries demanded more collateral for the short-term loans which provided funding for the banks. That pushed asset prices down and slowed liquidity to a trickle. When the wholesale credit markets crashed, panicky investors ran for the exits. The meltdown in subprime was the spark that set the shadow system ablaze.
Even so, Bernanke has fought all attempts to strengthen regulations, raise capital requirements, or tighten lending standards. Thus, the pieces of the shadow system have been reassembled with no fundamental change. Now it appears that the Fed’s bubblemaking efforts are starting to pay off. Here’s a clip from an article in the Wall Street Journal which clarifies the point:
"Even as lenders struggle to pull themselves out of the credit crisis, signs of a new and potentially dangerous infatuation with risky borrowers are emerging. From credit cards to auto loans to mortgages, the hunger for new business as the crisis ebbs is causing some financial institutions to weaken lending standards and woo borrowers who mightn’t be able to pay…..
“Credit-card issuers mailed 84.8 million offers of plastic to U.S. subprime borrowers in the first six months of this year…Fannie Mae, seized by the U.S. government in 2008 to avert the mortgage company’s failure, launched an initiative in January that allows some first-time home buyers to get a loan with a down payment of as little as $1,000….The thawing securitization market for auto loans is helping AmeriCredit increase its loan staff and dealer network…Kathleen Day, a spokeswoman for the Center for Responsible Lending, said the consumer group is "seeing banks re-enter the subprime market at a steady clip and make loans to borrowers who don’t have the ability to repay.
“There is no doubt that the credit supply still is tight….But some lenders are starting to take more chances on consumer loans. Many financial institutions that survived the credit crisis and resulting recession are desperate for earnings growth." ("Signs of Risky Lending Emerge" Ruth Simon, Wall Street Journal)
Financial system instability is no accident. It’s Central Bank policy. As financial institutions discover they can no longer count on organic growth in the real economy to increase profits, (because consumers are too strapped to spend freely) they will rely more heavily on dodgy accounting, bogus ratings, opaque debt-instruments, high-frequency trading and lax lending standards. This is the shadowy regime that Bernanke is trying so hard to rebuild. The Fed is laying the groundwork for another disaster.
MIKE WHITNEY lives in Washington state. He can be reached at firstname.lastname@example.org