The problem lies with the unregulated "shadow banking system" ...
Roots of a Financial Crisis: While the Regulators Fiddled ...
time.com
... starting in 2003, as a long boom in house prices and mortgage lending that had at least some foundation in economic reality (lower interest rates, higher incomes) gave way to an orgy of ever-sharper price increases fueled by ever-dodgier loans, the folks in the drivers' seat were the mortgage brokers that made the loans and the Wall Street investment banks that packaged them into private-label mortgage-backed securities.
And these people were barely regulated at all, at least not in the sense that bankers are regulated. "You had a regulatory mechanism that was targeted very narrowly to prudential regulation of the banking industry," says Gene Ludwig, who as Comptroller of the Currency oversaw the nation's big banks from 1993 to 1998. What that did, Ludwig explains, was to motivate banking companies to move activities to their less-regulated affiliates, and give a leg up to competitors (stand-alone investment firms, hedge funds, mortgage brokers, you name it) that weren't being watched by banking regulators at all.
Pyramids Crumbling (Bill Gross | January 2008)
pimco.com
But today’s banking system as pointed out in recent Investment Outlooks, has morphed into something entirely different and inherently more risky. Our modern shadow banking system craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever. Financial derivatives of all descriptions are involved but credit default swaps (CDS) are perhaps the most egregious offenders. While margin does flow periodically to balance both party’s accounts, the conduits that hold CDS contracts are in effect non-regulated banks, much like their hedge fund brethren, with no requirements to hold reserves against a significant "black swan" run that might break them. Jimmy Stewart—they hardly knew ye! According to the Bank for International Settlements (BIS), CDS totaling $43 trillion were outstanding at year end 2007, more than half the size of the entire asset base of the global banking system. Total derivatives amount to over $500 trillion, many of them finding their way onto the balance sheets of SIVs, CDOs and other conduits of their ilk comprising the Frankensteinian levered body of shadow banks. |
