What’s Wrong with the World

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What’s Wrong with the World is dedicated to the defense of what remains of Christendom, the civilization made by the men of the Cross of Christ. Athwart two hostile Powers we stand: the Jihad and Liberalism...read more

Shadow banking.


US regulators released some signal financial numbers last week. As the Financial Times reported, “The US financial sector's losses on large loans exploded in 2009, exceeding the combined losses since 2001, with hedge funds and other members of the ‘shadow banking system’ hit the hardest.” These non-bank institutions “held 47 per cent of problem loans in spite of accounting for only 21.2 per cent of the total loan pool.” Shadow banks, which generated such handsome returns in good times, today, in bad times, are on the floor.

Shadow banking. The invidious edge in the term is not, in my mind, unjust. There is definitely a shadowy aspect to this; but it is not so much, as liberals would have it, in the fact that the shadow banks were nefariously unregulated, real free radicals of capitalism betting like gamblers; it is in the fact that, off at the end, public capital would have to be substituted for the private capital that once drove their business.

To those who would answer that public capital should never have been committed, I must say there are certain considerable difficulties that confront you. (a) Virtually all the participants, from both government and industry, did truly believe that, whether we knew it or not, we all faced in that moment the possibility of irremediable calamity; the very crack of doom yawned before us. (b) Even if that judgment is wrong, there is still the fact of the actual statutory obligations of, say, a Fed Chairman. Does Bernanke even have the authority to adopt a policy of studious neglect of the unraveling of the financial system? It seems to me that his office entails an allegiance to stability which precludes running the experiment of an advanced capitalist economy operating with no banking system.


What is a shadow bank? As I understand it, a shadow bank is a financial institution operating outside the heavy regulation of the traditional banking sector, but basically doing the same thing that banks do: borrowing short and lending long — only its activities are notably more aggressive. A huge chunk of those long-term loans, we now know, were into fields of really speculative investment, above all in US housing. And now the short-term borrowing from the private sector has dried up. The securitization markets lies in ruins (though we have seen some uptick recently). Realistically, the primary demand driver is government capital.

Reasoning, then, from what this reveals, I propose that moral hazard was woven into the very fabric of shadow banking as such. In other words, the industry actually depended in a decisive way upon the expectation that, off at the end, its key players would be rescued from ruin by government capital.

The only remedy to this would have been a sacred and unbending public pledge, almost constitutional in significance, never to wager a dollar of public money to rescue a non-bank bank, a shadow bank.

To even state such a remedy is to demonstrate its practical folly. Not merely the idea of a kind of second Philadelphia Convention, called to proclaim to all the wide world that shadow banks are on their own; but indeed consider that it was precisely an attempt (however reluctant) to deliver this statement — I mean the ultimately laissez faire treatment of Lehman Brothers at its extremity as a going concern — that triggered the near-calamity.

In brief, the principle that would remove moral hazard from shadow banking is not conceivable in practice, given the state of affairs, our statutory commitments, and indeed our recent history as a commercial republic.

Comments (11)

Would it not do better service to all to awaken? There is no shadow. There is socialized banking, with the Federal Reserve firmly in place at the lead, and various ancillary regulations coming down from Washington, which had the net effect of forcing banks towards inappropriate lending for mortgages, for growth in homeownership was a bipartisan effort such that no mere child of the state (corporations) could disobey without facing destruction.

Nah, the shadows are part of the lullaby sung to keep you asleep while they leach out the very last little value of that dollar in your pocket. This is state-sanctioned theft at a grand scale, the leviathan in the china shop, garish and visible in the sunlight- and yet they convince you to chase shadows?

Sigh. We're not avoiding the calamity by refusing the demands of justice. We're merely pushing the destruction off to future generations and enabling it to grow worse. In the end, the Lord will judge in justice, and in that I take solace.

Albert -- where is the obvious and imperative demand of justice in this damnable mess? Do you mean to claim that rescuing the banks and shadow banks was an undeniable instance of injustice? To me that is dubious dogmatism indeed.

The Lord will judge indeed, and therein lies our solace. But He will judge not only those whose recklessness brought us to this pass; he will also judge the prudence of those whose fate it was to be pressed with the urgency of crises not of their own making.

August -- I'm having trouble deciphering your comment. I am convinced of the utility of talking of "shadow banking"; my view is that the term is useful and even advantageous for explication by principles of economic science or moral philosophy. In other words it is meet that we might speak of shadow banking in the terms of regulatory arbitrage (an economic concept) or in terms of moral hazard (a philosophic concept).

What of this generation and those that immediately follow? Where is the justice in allowing those who had no say in the policies, schemes and bubbles that have brought us to this point, to bear the direct consequences for them? Sounds like a form of collective guilt is being proposed and it should be noted the suffering is far from over for millions of Americans who are just barely hanging on to their jobs and homes.

Albert, if you are asking why has no one been held accountable and how can we avoid a replication of this crisis if we don't punish those responsible, then most share both your outrage and confusion. We all desire to build something better than what has passed for our political economy, however, smoldering ruins make for a poor foundation. We'll be going through a protracted and radical adjustment to our way of life in the years ahead, a key will be to avoid creating conditons from which only demagogues and tyrants emerge.

Paul, I wish just once, you would let your anger show in your dispassionate analysis, and not be afraid to kick over a table in the Temple every now and then.

Heh. Well, I have a hard time seeing the utility of that in a mere blog post. If I have someone in my presence, and the opportunity presents itself, I will not refrain for a bit more, shall we say, colorful rhetoric. But the art of persuasion lends itself to different approaches in different situations.

We'll be going through a protracted and radical adjustment to our way of life in the years ahead, a key will be to avoid creating conditons from which only demagogues and tyrants emerge.

As if demagogues and tyrants weren't already the bulk of the people getting sent to D.C. under the status quo...

As if demagogues and tyrants weren't already the bulk of the people getting sent to D.C. under the status quo

Well then, imagine the kind of leadership we could expect when saddled with 20% plus unemployment, unpaid pensions, a pronounced decline in routine public services and safety, and a fraying of all the other fragile, subtle threads of civilization that we take for granted. Right now, our political class is holding its collective breath, and hoping for a "Next Big Thing" (wind-mill manufacturing and installation, carbon tax credit sales, or a booming tourism industry catering to Asian visitors) to come along and re-inflate us back into a life of consumption and faux prosperity. Anything it seems, but begin to face reality and plan accordingly.

Problem: over the last hundred years, our economy changed from being based on making the stuff we use, and using what we have available to us, and exporting a lot more to others, to nearly the reverse: we import much of the stuff we use, and borrow on credit to do so. That is the basic problem. Most of our work is not productive of new wealth, it is merely re-arranging the wealth that we do have and borrow from others. The banking mess is merely the mechanics of how we manage the borrowing and maintaining the pretense that we are living within out means (and, indeed, by disguising it, we encourage more of the same). The moral reality is that we have grown accustomed to living beyond our means. This is simply greed. Probably not the worst form of greed, but greed nonetheless.

Eventual corrected situation: we must eventually be a people who makes what we use, and chooses to do without when we cannot afford some good that can be imagined but we cannot pay for now. This is the virtue (and a virtue that is both public and private) that is lacking.

Road map to getting to the eventual corrected situation: nobody has a solid claim to the best path to a solid footing. Some say we simply cut out the stupid evils of banking with monopoly money altogether; others say that a gradual approach is necessary to avoid the disruptions that will bring on still worse evils.

Is it possible that both are in some sense true? I would be MUCH more amenable to the notion that a gradual evolution is better than an economic revolution (or cleansing, if that is a more just term), if only there was broad agreement on what are the evils of the current system and where we wanted eventually to be as a nation. Without a generally agreed objective, how can progress be expected? On the other hand, those who advocate letting the banking industry collapse have proposed no vision of how to deal with the massive unemployment, massive loss of services (including police, medical, etc) is to be managed without grave unrest to the point of riots and political revolution anyway. And the fact that once you have political revolution, you cannot reasonably predict the outcome, so you cannot have confidence the outcome will be an improvement.

Some might say that we need a "little collapse" to get people to realize the danger and commit to a more just and sustainable end goal. Would that work? Did 9-11 make people truly commit to working to unravel the threat of Islamic terrorism? Did the economic near-collapse of 2008 change people's hearts?

Without a generally agreed objective, how can progress be expected?

The task of establishing a moral consensus falls to us. We must give the true account of economics and its proper place in human society. It is a means for serving others and an expression of our Christian vocation. It is not an end in, and of itself. The gift of work allows us to creatively share in God's own labors. It is not the means for conforming creation to our own narrow wants and interests. We need to shatter many of the assumptions, and ditch the dishonest language that has caused so much moral confusion. Christians do not refer to their co-workers and neighbors as units of production/consumption, cost overhead, or targets of opportunity. What are people for? We have the answer and it is time to share it with a people who know deep down something is dramatically wrong with the current ethos distorting our social arrangements. There is no excuse for retreating back to a discredited dialectic and tired ideological default points.

Some might say that we need a "little collapse" to get people to realize the danger and commit to a more just and sustainable end goal. Would that work? Did 9-11 make people truly commit to working to unravel the threat of Islamic terrorism? Did the economic near-collapse of 2008 change people's hearts?

Good point. Let’s hope and act as if we can make the necessary, gradual changes without incurring more heartache, loss and financial destruction. Today's unemployment figures and the reported status of unpaid bank loans simply mean we have to act faster in introducing Christian anthropology to our friends. We’ll have disagreements along the way on details, but surely we can agree on this modest point.

Paul, my rationale was explicated at length during my argument with Zippy on this website during the TARP bailout. I have little desire for a repeat performance.

As for your well-intentioned position, well, that way lies the continuation of the disorders our polity is experiencing. We'll see if the requisite change happens by the road you'd have our leaders travel. I do hope you're right, since it seems the likely course for the near future, though I don't expect it.

We'll see if the requisite change happens by the road you'd have our leaders travel.

I don't think anyone wants reform of the banking system designed by bankers, but that appears to be the next step. We will have, once again, a worst of both worlds scenario, with an additional government agency added to the federal deficit, but one that is sufficiently defanged from protecting us against the next grand swindle;

The administration’s outline for this new agency — which would regulate mortgages, credit cards, debit cards, installment loans and any other product issued by a financial institution — was sent up to Capitol Hill in July. Since then, Barney Frank, the committee chairman, has made a number of substantial changes, none of which, I have to say, have strengthened the proposed legislation. He stripped the bill of the much-promoted “plain vanilla” provision, which would have forced, say, mortgage brokers to offer customers a 30-year fixed mortgage alongside any exotic option A.R.M. mortgage they wanted to push.

He has changed the nature of an oversight panel, so that it would consist of the top bank regulators — the very same regulators who did such a miserable job looking out for consumers during the housing bubble. He has tinkered with the way the agency will be financed, making it less onerous for the banking industry and more onerous for nonbank financial institutions that will come under the agency’s purview.

Saddest of all — at least from where I’m sitting — he abandoned the so-called reasonableness standard, which would have forced bankers to make sure their customers both understood the products they were buying and could afford them. Mr. Frank has said that such a provision would put bankers in an “untenable position.” Yet that is precisely what brokers are required to do when they sell a stock or a bond to their customers. Why shouldn’t the same standard apply to a banker making a mortgage loan?


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