Shadow Banking System

Shadow Banking System

Dogs Dealing Unregulated Securities, after C.M. Coolidge (Mike Licht).

The financial crisis wasn’t caused by mortgages — or mortgage-backed securities, Fannie Mae, or space aliens. It wasn’t trading in CDOs (Collateralized Debt Obligations) but the market in REPOs (repurchase agreements ) which produced a plain old panic in the new-fangled nonbank shadow financial sector. Old fashioned investment banks had morphed into broker-dealer banks and could not survive a “run on the bank” any more than conventional banks.

How large was this shadow banking system? How big is it now? Nobody knows. The system is not just unregulated; it is unmeasured and unobserved.  Yale’s Gary Gorton estimates it at $12 trillion, and his study explains how this house of cards grew as large as conventional banking before collapsing and bringing down the world economy.

So now we have a better explanation of how and why the financial crisis happened, an arcane but convincing explanation that makes collapse seem inevitable but offers no solutions to avoid future economic disasters. What a comfort.

Note: The graphic does not truly represent nonbank transactions, as there is some cash on the table.

Image (“Dogs Dealing Unregulated Securities, after C.M. Coolidge” ) by Mike Licht. Download a copy here. Creative Commons license; credit Mike Licht, NotionsCapital.com

For information on artist and banker Cassius Marcellus Coolidge (1844 — 1934), look here.

Comments are welcome if they are on-topic, substantive, concise, and not boring or obscene. Comments may be edited for clarity and length.

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