FREE ELECTRONIC LIBRARY - Abstracts, books, theses

Pages:   || 2 | 3 | 4 |

«2011-2012 IT’S ALL SHADOW BANKING, ACTUALLY 593 IT’S ALL SHADOW BANKING, ACTUALLY JONATHAN MACEY* Introduction “Shadow banking” is a great term. ...»

-- [ Page 1 ] --





“Shadow banking” is a great term. Although the term fails to

impart much meaning, it manages to convey the impression that,

whatever it is, it must be nefarious, somewhat clandestine and of

dubious legality. To those who have some familiarity with shadow banking, the term seems an apt label for a financial world that, albeit legal, sometimes is nefarious and somewhat clandestine.

Since the shadow banking system is, at times, even larger than the regular banking system, it is important to understand what the shadow banking system actually is and does. Determining whether the shadow banking system imposes “negative externalities,” i.e. costs on innocent third parties, like taxpayers, also seems like a worthwhile endeavor.

In this article, I intend to show that shadow banking is no different than regular banking. Although some commentators suggest that shadow banks escape the stringent regulation that regular banks are subject to,1 I will show that this is often not the case. More importantly, the shadow banking system produces the same economic benefits as those that come from the traditional banking system. In fact, as a matter of economic substance, there is no difference between the shadow banking system and the traditional banking system. That is the good news. The bad news is that, properly understood, we should worry about traditional banking at least as much as we worry about shadow banking—probably even more.


* Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law, Yale Law School.

See, e.g., Bill Gross, Beware our Shadow Banking System, CNN MONEY (Nov. 28, 2007, 10:58 AM), http://money.cnn.com/2007/11/27/ news/newsmakers/gross_banking.fortune/ (“My... colleague Paul McCulley has labeled it the ‘shadow banking system’ because it has lain hidden for years, untouched by regulation, yet free to magically and mystically create and then package subprime loans into a host of three-letter conduits that only Wall Street wizards could explain.”).

594 REVIEW OF BANKING & FINANCIAL LAW Vol. 31   I. Shadow Banking: A Concise Description Despite the fact that its exact contours remain unclear, the sheer size of the shadow banking system is astounding. In June 2008, Timothy Geithner, then the Chief Executive Officer of the Federal Reserve Bank of New York, estimated that in early 2007 the assets held by all institutions in the entire banking system, including holding companies, was “about $10 trillion,”2 while the assets in the shadow banking system were about $10.5 trillion.3 Given how opaquely the term shadow banking is often defined, it is hardly a wonder that shadow banks are shrouded in mystery. For example, a Federal Reserve Bank of New York report

defines shadow banks as:

[F]inancial intermediaries that conduct maturity, credit, and liquidity transformation without access to central bank liquidity or public sector credit guarantees. Examples of shadow banks include finance companies, asset-backed commercial paper (ABCP) conduits, limited-purpose finance companies, structured investment vehicles, credit hedge funds, money market mutual funds, securities lenders, and government-sponsored enterprises.4 Simpler definitions are often no more reassuring. According to Investopedia, an online resource whose self-stated goal is to “empower the individual investor” through education,5 the shadow banking system consists of “the financial intermediaries involved in


Timothy F. Geithner, President and Chief Exec. Officer, Fed. Reserve Bank of N.Y., Remarks at The Economic Club of New York: Reducing Systemic Risk in a Dynamic Financial System (June 9, 2008).

Id. Mr. Geithner reached this $10.5 billion figure by adding the value of asset-backed commercial paper conduits, structured investment vehicles, auction-rate preferred securities, tender option bonds, variable rate demand notes, assets financed through overnight tri-party repurchase agreements, assets in hedge funds and the assets on the balance sheets of the major investment banks.




to SHADOW BANKING (2010), available at http://www.newyorkfed.org/research/staff_reports/sr458.pdf.

About Investopedia, INVESTOPEDIA, http://www.investopedia.com/ corp/about.asp#axzz1nOIMu000 (last visited Feb. 25, 2012).

2011-2012 IT’S ALL SHADOW BANKING, ACTUALLY 595 facilitating the creation of credit across the global financial system, but whose members are not subject to regulatory oversight. The shadow banking system also refers to unregulated activities by regulated institutions.”6 Yikes. That sounds bad.

–  –  –

I propose an alternative way to understand shadow banking.

Imagine that a financial institution sells $250 million in securities, on a very short-term basis, to a large investor. The buyer, who only wants to invest on a short-term basis, demands and receives a contractual guarantee from the selling financial institution that obligates that institution to buy those securities back the next day.

Imagine further that the financial institution takes the $250 million that it receives in this one day “sale”, and uses it to fund a long-term project, like the purchase of an illiquid investment that does not mature for eight years or the construction of a power plant. Finally, imagine that the financial institution is counting on selling another $250 million—or more—in securities tomorrow, and using the proceeds of that sale to repurchase the securities it sells today.

A repurchase agreement, or “repo”, like the kind of transaction described above is the paradigmatic example of the sort of transaction that takes place in the shadow banking system. Other transactions in the shadow banking system may take a different form, but the basic idea is the same. For example, if a corporation sells commercial paper, which is simply a short-term promissory note that matures within ninety days or less, and uses the proceeds to fund longer-term projects, that corporation participates in the shadow banking system.

B. Special Purpose Vehicles and Special Purpose Entities

In addition, what is known colloquially as “off-balance financing” also plays a major role in the world of shadow banking.

Off-balance sheet financing, as the name implies, allows a regulated entity to ignore certain assets and debts for regulatory and accounting


Shadow Banking System, INVESTOPEDIA, http://www.investopedia.com/ terms/s/shadow-banking-system.asp#axzz1jwYGKow1 (last visited Feb. 25, 2012).

596 REVIEW OF BANKING & FINANCIAL LAW Vol. 31   purposes. The term describes lending and borrowing activity that takes place through “remote entities”, or subsidiaries, which treat the assets and debts used in the financing as their own, thereby moving the assets and debts off the balance sheet of the regulated entity. If a financial institution, for example, were to keep an asset on the balance sheet, the financial institution would have to allocate precious, costly capital to cushion itself against the possibility that the asset could decline in value. Likewise, when a financial institution keeps a liability on its balance sheet, the bank’s capital would be reduced by the amount of the debt obligation, thereby reducing the amount of its lending and trading and other profitable activity, and possibly pushing the bank’s capital levels closer to or above regulatory minimums. In extreme cases, allowing a liability to fester on an institution’s balance sheet could even push the institution into bankruptcy.

To facilitate off-balance sheet financing, a bank or other financial institution generally will form a “special purpose vehicle” (“SPV”) or a “special purpose entity” (“SPE”). The SPE issues debt to investors and uses the proceeds of the debt issue to buy assets from the sponsoring financial institution, like home mortgages or, as in the case of Enron, other troubled or worthless products. Large financial institutions regularly use SPEs to remove assets and liabilities from their own balance sheets. Economist Darrell Duffie observed that “in June 2008 Citigroup reported over $800 billion in off-balance sheet assets held in [what the bank called] ‘qualified special purposes entities.’”7 A special kind of SPE known as a “structured investment vehicle” (“SIV”) sells debt, such as short-term commercial paper, to financial institutions and uses the proceeds to buy residential mortgages or other long-term assets. Many SIVs suffered during the 2007 and 2008 financial crisis, as home prices fell sharply and the number of mortgage defaults and foreclosures rose drastically.8 Needless to say, the money market funds and other financial companies that had purchased short-term debt from the SIVs also suffered losses.9 Although they were not legally required to honor the





See Eric Dash, Investor Safe Haven Becomes a Concern, N.Y. TIMES, Nov. 14, 2007, at C1 (“In another sign of turmoil in the credit markets, large investment firms, having sought out the high-yields for their money market 2011-2012 IT’S ALL SHADOW BANKING, ACTUALLY 597 debts of these remote juridical entities, financial institutions such as HSBC, Rabobank and, most notably, Citigroup bailed out their SIVs by putting the SIVs’ assets and liabilities on their own balance sheets.10

–  –  –

A credit default swap (“CDS”), an example of a shadow banking transaction utilized by both regular banks and shadow banks and pioneered by J.P. Morgan in 1997, is the most widely used credit derivative.11 An institution that buys a CDS enters into a contractual agreement that gives it the right to receive a cash payment upon the occurrence of a specified event, such as default, downgrade by a credit rating agency or any other “credit event” that would otherwise negatively affect the institution. Some institutions use CDSs to “hedge” against the effect of an event that negatively impacts the credit-worthiness of the issuer of debt that the institution holds as an asset, such as sovereign debt issued by developing countries, corporate debt or mortgage-backed securities. For example, Goldman Sachs prodigiously purchased CDSs on its portfolios of mortgagebacked securities and other real-estate related assets from the insurance company American International Group (“AIG”), likely a source of great solace to Goldman and of great aggravation for AIG12 Goldman received even more solace when the U.S. Treasury ensured


funds, are being forced to protect the funds from losses brought on by investments that no longer seem safe.... Bank of America said yesterday that it would provide as much as $600 million to prop up several Columbia Management funds, which bought large amounts of debt issued by structured investment vehicles, or SIVs, that is now worth less than it paid.”).

Liz Moyer, Citigroup Goes it Alone to Rescue SIVs, FORBES.COM (Dec.

13, 2007, 11:24 PM), http://www.forbes.com/2007/12/13/citi-siv-bailoutmarkets-equity-cx_lm_1213markets47.html.

A credit derivative is simply a contract that enables one party to an agreement to manage its exposure to credit risk. Swaps, forward contracts and options are all used as credit derivatives.

See Gretchen Morgenson, Behind Insurer’s Crisis, Blind Eye to a Web of Risk, N.Y. TIMES, Sep. 28, 2008, at A1 (explaining how A.I.G.’s CDS exposure and “its relationship with firms like Goldman offers important insights into the mystifying, virally connected—and astonishingly fragile— financial world”) 598 REVIEW OF BANKING & FINANCIAL LAW Vol. 31   a further windfall to Goldman when it awarded Goldman 100% of what it was owed on these CDSs despite AIG’s financial collapse.13 In essence, CDSs function like insurance contracts. They are called “swaps” because the buyer of these contracts makes both initial and periodic payments to the guarantor, who obligated itself to pay in the event of a credit event, and because the seller, who accepts payment for assuming certain risks on the buyer’s behalf, must deliver the value of principal and interest payments that the underlying asset would have paid to the buyer if no credit event occurs. In addition, if and when the person who bought the CDS begins receiving payments from the seller, the agreement usually requires the buyer to deliver to the seller either the current cash value of the underlying security or the security itself.

While CDSs function much like insurance, CDSs are not called insurance for a rather technical reason.14 Unlike pure insurance contracts in which a policy seller does not pay unless the beneficiary incurs an actual loss, CDS contracts do not require an actual loss as a condition of payment (although an actual loss of principal will result in payment).15 Nevertheless, while outside this narrow definition, CDS contracts have many characteristics of insurance.

The very controversial implications of the fact that CDSs generally are not considered insurance are two-fold. First, since the mid-eighteenth century, insurance contracts have been subject to the requirement that only someone with an “insurable interest,” an interest in the continued existence of the insured property, may purchase protection on that interest.16 Because CDSs are not considered insurance contracts, they are not subject to the requirement that they can only be purchased by those with an


See generally Louise Story & Gretchen Morgenson, Inside the U.S.

Bailout of A.I.G.: Extra Forgiveness for Big Banks, N.Y. TIMES, June 30, 2010, at A1.

For an overview of the difficulty of classifying CDSs, see Stacy-Marie Ishmael, Repeat After Me: CDS are not Insurance, FT.COM/ALPHAVILLE (Mar. 9, 2009, 8:59 PM), http://ftalphaville.ft.com/blog/2010/03/09/ 169811/repeat-after-me-cds-are-not-insurance/.

Id. (quoting Sec. Indus. & Fin. Mkts. Ass’n, Frequently Asked Questions About CDS, SIFMA, http://www.sifma.org/issues/regulatory-reform/otcderivatives/resources/ (follow “Frequently Asked Questions About CDS” hyperlink) (last visited Apr. 7, 2012)).

See generally Kyriaki P. Noussia, Insurable Interest in Marine Insurance Contracts: Modern Commercial Needs Versus Tradition, 39 J. MAR. L. & COM. 81 (2008) (discussing the concept of insurable interest).

Pages:   || 2 | 3 | 4 |

Similar works:

«DISQUALIFICATION OF OPPOSING COUNSEL Under ABA Model Rule 3.7 Lawyer As Witness AMERICAN BAR ASSOCIATION Section of Labor and Employment Law Committee on Ethics and Professional Responsibility 2010 Mid-Winter Meeting Presented by: Joseph Chairez, Baker & Hostetler, LLP, Costa Mesa, CA Steven W. Moore, Ogletree, Deakins, Nash, Smoak, & Stewart, P.C., Denver, CO Stephanie S. Padilla, Johns Manville Corporation, Denver, CO Mark D. Risk, Mark Risk, P.C., New York, NY Employment litigators must be...»

«Testimony of Lucy A. Dalglish, Executive Director Reporters Committee for Freedom of the Press on behalf of the Sunshine in Government Initiative before the House Oversight and Government Reform Committee On “Addressing Concerns about the Integrity of the U.S. Department of Labor’s Jobs Reporting” June 6, 2012 Chairman Issa, Ranking Member Cummings, and members of the Committee, Thank you for the opportunity to testify today. I am Lucy Dalglish, executive director of the Reporters...»

«Case 9:16-cv-00065-DWM Document 1 Filed 05/03/16 Page 1 of 14 Sarah McMillan WildEarth Guardians P.O. Box 7516 Missoula, Montana 59807 Tel: 406-549-3895 smcmillan@wildearthguardians.org Matthew K. Bishop Western Environmental Law Center 103 Reeder’s Alley Helena, Montana 59603 Tel: 406-324-8011 bishop@westernlaw.org Counsel for Plaintiff IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MONTANA MISSOULA DIVISION WILDEARTH GUARDIANS, Case No.: Plaintiff, COMPLAINT vs. CRAIG HOOVER;...»

«A Primer on 30(b)(6) Depositions A Defense Perspective David L. Johnson Kyle Young MILLER & MARTIN PLLC Nashville, Tennessee dljohnson@millermartin.com kyoung@millermartin.com 134 To Depose or not to Depose Johnson D.DOC At first blush, selecting an individual to serve as a corporate representative in a lawsuit may seem like a mundane task. Selecting the wrong individual, however, can prove disastrous. Defense counsel should not take corporate representative depositions lightly. Counsel should...»

«Approaching new migration through Elias’ ‘established’ and ‘outsiders’ lens Olga Petintseva Department of Criminology, Penal Law and Social Law, Ghent University, Belgium. E-mail: olga.petintseva@ugent.be Tel. (+32) 9 264 97 04 (+32) 497 74 89 54 Fax (+32) 9 264 69 88 Approaching new migration through Elias’ ‘established’ and ‘outsiders’ lens Abstract When considering social positions and features that become distinguishing for migrants’ positioning, scholars quite often...»

«AD HOC WORKING GROUP ON THE DURBAN PLATFORM FOR ENHANCED ACTION ADP.2015.8.InformalNote Non-paper Note by the Co-Chairs 5 October 2015 A. DRAFT AGREEMENT [ The Parties to this Agreement, Pp1 Being Parties to the United Nations Framework Convention on Climate Change, hereinafter referred to as “the Convention”, Pp2 In furtherance of the objective of the Convention, Pp3 Recalling decision 1/CP.17, whereby the Conference of the Parties to the Convention decided to adopt a protocol, another...»

«2013 BNH 008 Note: This is an unreported opinion. Refer to LBR 1050-1 regarding citation. UNITED STATES BANKRUPTCY COURT DISTRICT OF NEW HAMPSHIRE In re: Bk. No. 12-11392-JMD Chapter 13 Jared I. Stevens, Debtor Robert M. Moore Moore Devlin Law, PLLC 530 Chestnut Street; Suite 2D Manchester, NH Attorney for Debtor Carl E. D’Angio, Jr. D’Angio Law Office 11 Spring Street Waltham, MA Attorney for Creditor Peter Gazzara MEMORANDUM OPINION I. INTRODUCTION The Court has before it creditor Peter...»

«INSPECTION SOLUTIONS FOR THE AUTOMOTIVE INDUSTRY – SPOTCHECKER AND USLT-USB Joerg REINERSMANN, Paul BUSCHKE, GE Sensing & Inspection Technologies GmbH, Huerth, Germany Introduction The almost globally existing liability act for manufacturers, specifically OEM´s in the automotive industry always leads to the need to take a closer look to the safety of cars and transport vehicles. For instance, within the Russian Federation the liability of producers is well-regulated in the Federal Law “On...»

«© F A R Bennion Website: www.francisbennion.com Doc. No. 2006.015 15 Com L (April 2006) 17 Any footnotes are shown at the bottom of each page For full version of abbreviations click ‘Abbreviations’ on FB’s website. Page 17 Separation of Powers in Written and Unwritten Constitutions Francis Bennion This article was prompted by an interesting survey by an Irish judge contained in a recent issue of this journal, “Socio-economic Litigation and the Separation of Powers” by Adrian...»

«Dispensing Equipment Testing With Mid-Level Ethanol/Gasoline Test Fluid Summary Report November 2010 Kenneth Boyce, Principal Engineer Manager – Energy J. Thomas Chapin, Vice President – Corporate Research Underwriters Laboratories Inc. 333 Pfingsten Road Northbrook, Illinois 60062 i This publication received minimal editorial review at NREL. NOTICE This report was prepared as an account of work sponsored by an agency of the United States government. Neither the United States government nor...»

«Laws and Consequences.for youth.for adults.for you Salt Lake County Division of Youth Services WHAT THE JUVENILE COURT CAN DO A. GENERALLY The Juvenile Court has the authority to deal with cases involving persons under 18 years of age, persons 18 years or older whose offenses occurred when the person was under the age of 18 and are under the continued jurisdiction of the Court. The Juvenile Court can maintain jurisdiction over any person up to the age of 21. The Juvenile Court can retain...»

«GAS LAW INVESTIGATION INTRODUCTION Description This experiment requires two lab periods. In the first lab, students investigate the reaction of an Alka-Seltzer® tablet and water to determine the variables that affect the amount of gas produced from the reaction. Students also become familiar with the use of the gas collection apparatus. In the second lab, students pick from one of two scenarios. Each scenario involves a gas evolution experiment. Students use the gas collection apparatus from...»

<<  HOME   |    CONTACTS
2017 www.sa.i-pdf.info - Abstracts, books, theses

Materials of this site are available for review, all rights belong to their respective owners.
If you do not agree with the fact that your material is placed on this site, please, email us, we will within 1-2 business days delete him.