Shadow Boxing

What is the shadow banking system?

Many note that the banking crisis of 2008 was primarily a crisis of the shadow banking system, although few know what that is. But if we want to plan for the next crisis, we need to understand the last one.

The shadow banking system is a product of banking regulation. In the ‘70s, banks were subject to Reg Q, which limited the interest they could pay. Naturally, 4% interest wasn’t very attractive to investors with inflation at 10% or higher. So some folks figured that by pooling their funds and investing in short-term instruments, they could earn a lot more than banks could pay.

Thus was born the first shadow banking institution, the money market fund. It pays interest to depositors and lends to corporations and the government. Today, the shadow banking system is a lot of funds that serve banking functions outside of banking rules. They may have rules, but not banking rules. AIG made markets in credit instruments, and when some of those bets went wrong their excessive leverage brought down the company. The big brokers made sub-prime loans, and when those loans went bad their excessive leverage brought them down.

It really was leverage that brought down the banking system, both shadow and traditional. Financial reform needs to address this. And not push people into a shadow-shadow world.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-12T10:54:49+00:00 June 10th, 2010|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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