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The Shadow Banking System

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Oxford University Press: Slapped by the Invisible Hand: Gary B. Gorton. Contagion Thesis Once Derided Proven by Kristin Forbes. When Kristin Forbes sought tenure at the Massachusetts Institute of Technology early last decade, some colleagues said her research focus on financial contagion led to a dead end.

Contagion Thesis Once Derided Proven by Kristin Forbes

Her reaction: Full speed ahead. Forbes worked to safeguard global financial stability with then-U.S. Treasury Undersecretary John Taylor, became the youngest member ever on the White House Council of Economic Advisers and eventually won tenure at MIT. In August she presented the opening paper at the Federal Reserve’s annual symposium in Jackson Hole, Wyoming. “Kristin is one of the leaders in the empirical analysis of contagion,” said Roberto Rigobon, who, like Forbes, is a professor of economics at MIT’s Sloan School of Management in Cambridge, Massachusetts, and has co-written research with her on the topic. Forbes, 42, says she still sees complacency over the risk that financial turmoil will spread beyond a single country, even with Europe’s struggle to curb its sovereign-debt crisis. Close Open Stress Test. The Odd Behavior of Repo Haircuts during the Financial Crisis. Adam Copeland and Antoine Martin Since the financial crisis began, there’s been substantial debate on the role of haircuts in U.S. repo markets.

The Odd Behavior of Repo Haircuts during the Financial Crisis

(The haircut is the value of the collateral in excess of the value of the cash exchanged in the repo; see our blog post for more on repo markets.) In an influential paper, Gorton and Metrick show that haircuts increased rapidly during the crisis, a phenomenon they characterize as a general “run on repo.” Consequently, some policymakers and academics have considered whether regulating haircuts might help stabilize the repo markets, for example, by setting a minimum level so that haircuts can never be too low, as discussed in another paper by Gorton and Metrick. In this post, we discuss recent findings showing that the rise in haircuts wasn’t a general phenomenon after all—haircuts didn’t rise in every repo market.

What is the Sadow Banking system?

Shadow Banking and the 2008 financial crisis. Shadow Banking System - curators.. Shadow Banking and Financial Regulation. Editor’s Note:Morgan Ricks is a visiting assistant professor at Harvard Law School.

Shadow Banking and Financial Regulation

Through June 2010, he was a Senior Policy Advisor and Financial Restructuring Expert at the U.S. Treasury Department. The views expressed herein do not necessarily reflect the views of the Department of the Treasury or the U.S. Government. This post is based on his paper “Shadow Banking and Financial Regulation,” available here. Without a safety net, banking is unstable. The apparent instability of banking has given rise to a standard policy response in the form of a social contract (a phrase borrowed from a marvelous speech by Paul Tucker of the Bank of England). [2] That contract entails certain privileges that are unavailable to other firms: most notably, access to central bank liquidity and federal deposit insurance. Historically, this social contract has been limited to depository banking—firms that take deposits and use them to invest in illiquid loans. Endnotes [1] Douglas W. The fallacy of financial regulation: neglect of the shadow banking system.

Shadow banking, part 1: Failure to reform shadows hurts economy, endangers financial markets. Updated June 18, 2012.

Shadow banking, part 1: Failure to reform shadows hurts economy, endangers financial markets

Shadow banking, part 2: Lack of shadow master plan means impact of new rules is uncertain. The shape of shadow banking reform is now clear.

Shadow banking, part 2: Lack of shadow master plan means impact of new rules is uncertain

Congress and regulators are going to put a bunch of new rules in place, but they’re not going to articulate a coherent vision of what shadow banking should, or should not, be. They’re going to clamp down on risk-taking at individual financial institutions, but they have no plan to protect the larger shadow banking system – like the FDIC protects traditional banking – from the runs that nearly collapsed the world’s financial markets in 2007 and 2008.

This hasn’t stopped some experts from trying to expand the conversation. Shadow banking, part 3: Some experts call for FDIC-style safety net for shadow banking. The financial crisis showed that the safety net for traditional banks can work.

Shadow banking, part 3: Some experts call for FDIC-style safety net for shadow banking

Although 436 banks failed from January 2008 through April 2012 – some large, like Washington Mutual, but none the size of Lehman Brothers – the FDIC handled them efficiently, depositors insured by the FDIC didn’t lose money, and the failures probably won’t cost taxpayers a dime. For some, this raises an obvious question: Why not devise a safety net for shadow banking?

From “Shadow Banking and Financial Regulation” by Morgan Ricks, Harvard Law School, September 18, 2010: Without a safety net, banking is unstable. (Editor’s note: See Shadow Banking, part 1 for an explanation of shadow banking and its problems. Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B? While much has been said about the vagaries in the European repo market elsewhere, the truth is that the intraday variations of assorted daily metrics thereof indicate three simple things: a scarcity of quality assets that can be pledged at various monetary institutions in exchange for cash or synthetic cash equivalents, a resulting lock up in interbank liquidity, and above all, a gradual freeze of the shadow banking system.

Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B?

As we have been demonstrating on a daily basis, we have experienced all three over the past several months, as the liquidity situation in Europe has gotten worse, morphing to lock ups in both repo and money markets. As a reminder, both repo and money markets (for a full list see here), are among the swing variables in shadow banking. Indicatively, of the $15.5 trillion in shadow US liabilities (by far the biggest such system in the world), $2.6 trillion are liabilities with money market mutual funds and just $1.2 trillion are repos. What explains this? A snapshot of collateral stress, courtesy of the Fed.

Keep an eye on this quarterly Fed study of repos. A shortgage of trusted repo collateral is slowing the flow of credit in the U.S. and in Europe, and that trend is showing up in a survey of the repo market now being conducted quarterly by the Federal Reserve.

Keep an eye on this quarterly Fed study of repos

Spotting this trend shows how important it is to keep a close eye on the repurchase market. Before the financial crisis of 2007-2008, the repo market could have told us that financial leverage was skyrocketing. But we weren’t looking. Even now, little is known about repo operations. But the Fed survey is a start. Responses to questions on securities financing pointed to a tightening of some of the terms under which a broad spectrum of securities were financed, although terms on equities financing were little changed. Finance Now Exists For Its Own Exclusive Benefit. Looking through the Byzantine maze of accounting interpretations and black box calculations that compose Bank of America's latest quarterly balance sheet presentation, you get the idea that the company has increased its exposure to derivative positions in the first three quarters of 2011 by about $6 billion on the asset side.

Finance Now Exists For Its Own Exclusive Benefit

In the context of these dangerous and volatile times, knowing what happened in 2008, that may not seem like a very good thing for the bank. There was also an increase in derivative liabilities, about $4 billion, so at least most of that increase was funded in the same arena (banks always want to match risks or net them out somehow). A $6 billion increase for a bank that has $2.219 trillion in assets seems rather trivial, however. Even looking at the derivative "exposure" in total, $79 billion, it does not appear to be anything out of the ordinary.

That $79 billion cumulative position only takes up 3.5% of the entire bank's portfolio. The Unravelling of Structured Investment Vehicles – Renowned financial economists examines the cataclysmic collapse of the global financial. Dr.

The Unravelling of Structured Investment Vehicles – Renowned financial economists examines the cataclysmic collapse of the global financial

Henry Tabe is the author of The Unravelling of Structured Investment Vehicles: How Liquiditiy Leaked Through SIVs: Lessons in Risk Management and Regulatory Oversight. Dr. Tabe is Chief Risk Officer and Head of Research at Sequoia Investment Management Company. Previously, he was Moody’s Investors Service Managing Director in Europe for Structured Finance Operating Companies (SFOCs) and complex structured credit transactions.