Shadow banking system

Time’s Foroohar Responds to Treasury: Our Financial System Is Not Stronger

Treasury's Anthony Cole blogged:

Point Four: Shadow Banking

The risk in the so-called “shadow banking system” – the financial firms that operated outside of the protections and constraints we impose on banks – has fallen substantially since the crisis.

Assets in the “shadow banking system” are roughly half the level seen in 2007. Funding through tri-party repurchase agreements has fallen 40 percent from its peak in 2007, and asset-backed commercial paper outstanding – which was often used to fund leveraged off-balance sheet vehicles – is a third of what it was in 2007.

​We now have the authority to subject, through designation by the Council, major financial companies operating in the United States to consolidated supervision and adherence to heightened prudential standards, such as enhanced capital, liquidity, and risk management requirements. That represents a dramatic change from before the crisis, when there was no authority for such regulation of such institutions, which comprised more than half of the financial activity in the nation.

Since the housing bubble popped, business people are now gun-shy. But the assets levels in the shadow banking system will rise again as the crisis fades from view and people become complacent yet again. They'll need to be risky in order to compete. There needs to be an FDIC system for the shadow banking system as there is for the regular banking system. But that will make it less profitable. Instead it depends on the regulators.

As Konczal reports, Jack Lew is not regulating very well. And he's a Democrat.

AIG failed because its derivatives position became impossible for it to manage. The Commodity Futures Trading Commission (CFTC) has made major progress in bringing the light of transparency to the over-the-counter derivatives market, making sure collateral and price transparency clean up the market.

They have hit resistance, though. As the economist Alan Blinder wrote earlier this week, the CFTC’s Gary Gensler “ran into a wall of resistance from the industry, from European regulators, and from some of his American colleagues when he tried to implement even the weak Dodd-Frank provisions for derivatives.”

It’s important to name the actual agents involved. Instead of a nebulous and nefarious blob of interests called “the industry,” there’s an actual human being putting pressure on Gensler to stop these cross-border regulations that tie U.S. firms in Europe to U.S. regulations. And, as Silla Brush & Robert Schmidt reported in a great Bloomberg piece, his name is Jack Lew, and he’s the Treasury secretary of the United States. 

It's possible Larry Summers will be a good regulator as Fed Chair. It could happen. But my bet would be that he'll turn out to be like Jack Lew here. More of the same.