Can the independent non-bank financial intermediaries survive in USA?

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The old world of banking has largely vanished–and been replaced by the shadow banking system.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.

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Bill Posters
Bill Posters
13 years ago

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.

Unfortunately for us all, the predictions of Anatole Kaletsky are reliably wrong.

JC
JC
13 years ago

Fred:

The US is not short of regulatory supervision. There are 70,000 pages of regulations that impinge on both the banking and the shadow banking system.

Regulating the shadow banks-what’s left of them- isn’t going to do a heap of good, as all it will do is basically send them into the arms to larger commercial banks. In fact that is pretty much a given now as both MS and GS will merge with large banking partners in a matter of months.

However I don’t really see what good that is going to achieve and if in fact it would make a scrap of difference to create a safer system. Citibank’s universal bank approach is what the future will look like aren’t exactly in any shape to present as an exemplar of virtue. Analysts are suggesting Citibank will be writing down about 20 billion over the next 4 quarters. They also have 45 billion in commercial real estate loans on their books and if the commercial real estate goes to the wall as indeed it might over the next few months citibank will be in huge amount of trouble. Citibank is a $2 trillion balance sheet by the way. It seems Citibank is the model the regulators are trying to create. Mind you UBS- another universal bank- is also in pretty big trouble too.

More sloppy banking regulation will simply create the situation where small boutique type of specialists shops will spring up that are totally unregulated. In other words speculation will simply move to the curbside and if they try to regulate that area hedge funds will move their operations offshore. We saw evidence of that with a great deal of debt and equity issuance moving to London after the Enron fisaco.

Here’s the right solution.

Remove most regulation and privatize the banking system completely. Let the banks buy deposit insurance from private issuers and have the government move away from regulating the banking system altogether so as to remove moral hazard. If the banks hire stupid managers then let the customers force change on them. The other thing they could do is accept the blame for the mess they have caused by allowing an out of control Federal Reserve system keep interest rates too low for too long causing the system to mis-price asset values and risk.

Finally make the congress liable for the shit they pulled back in 1998 when with the HUD and other Federal agencies(including the Fed too by the way) they forced credit standards to go into the toilet by accusing the large banks of “racist lending standards” because they didn’t have numerous lending operations in the poor neighborhoods. The HUD under Clinton bears a lot of responsibility for that licorice bar.

Next close down those socialist monoliths like Fred and Fannie as they simply create distortions and mis-pricing

lets learn from this mess for a change and place the blame where the blame lies which is totally with the Fed and the Congress. In fact both institutions ought to be tarred and feathered for what they have done. This is the perfect storm of government failure.

JC
JC
13 years ago

Here’s another factoid Fred that i forgot to mention.

They are Morgan Stanley and Goldman Sachs. They rely heavily on holdings of leverage and skittish funding (such as CDSs – 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.

Actually Morgan Stanley has pretty stable funding coming from their customer brokerage accounts. i don’t know the size but I do know that Merrill’s had $100 billion sitting in customer deposits which was pretty stable.

It’s not really about a stable deposit base, Fred, it’s about risk management. it’s about how these dudes manage risk vs capital allocation in the various businesses. There will be deleveraging going on but we shouldn’t lose site of where the true risks are.