They look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank like runs. But unlike banks, they are not properly regulated or supervised and dont have access to deposit insurance or the lender of last resort support of the central bank. — Nouriel Roubini.
The old world of banking has largely vanished–and been replaced by the shadow banking system. Depository banks now play a minor role.–The new system was supposed to do a better job of spreading risk. But it seems apparent that risk wasnt so much reduced as hidden. —Paulson seems to betting that part of the financial system can handle the shock of a Lehman failure. We will find out soon whether he was brave or foolish. — Paul Krugman.
The Fed saw the financial crisis as primarily a liquidity event —by now, everyone realizes this is a solvency crisis. — Tim Hay.
There are at least three reasons why these large institutions (investment banks, broker dealers, hedge funds, private equity funds, conduits etc.) may not survive in their present form in USA.
First, everyone (including Costello at today’s press conference) is wondering why, six months after Bear Stearns, there is still no special resolution regime for large investment banks along the lines of commercial banks. Those commercial banks that are subject to regulation now have access to lender of last resort facilities. These now include even equities and lending of any investment-grade security – not just triple-A rated – to the Fed in exchange for Treasury bonds. But the institutions have to comply with capital requirements and subscribe to depositi insurance.
Secondly, there are only two institutions which can be called major left in the USA. They are Morgan Stanley and Goldman Sachs. They rely heavily on holdings of leverage and skittish funding (such as CDS’s – mortgage-linked collateralised-debt obligations). As a result, they have to cope with a very large increase in spreads on both their banks borrowings. They are very vulnerable and need to become more dependent on the security of a commercial deposit base. These large institutions have to be integrated into the regulatory system.
Thirdly, while relatively large institutions can expect to be treated like trading banks, it is important to ensure there is adequate competition in the system from smaller (less consequential) non-bank sources. These smaller institutions should still be subject to greater supervision but to a much lesser extent than the banks.
All this will not help this time around. The question that now emerges is whether Anatole Kaletsky is right or wrong when he puts up the argument that the US real economy will not suffer to the same disastrous extent implied by the financial crisis. If he is right, this may turn out to be a little blip (less so in Europe). If he is wrong, then we are close to a serious recession.
Many of the implications of the above apply equally to Australia. For example, our trading banks are not subject to deposit insurance, whereas the US banks are.