[THS] Mike Whitney: Shadow Banking Makes A Comeback

[The Harder Stuff in news and commentary]

http://www.informationclearinghouse.info/article25999.htm

Shadow Banking Makes A Comeback

By Mike Whitney

July 22, 2010 "Information Clearing House" -- 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 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.