The Temple Grandin of Shadow Banking Part 2
In Part 1 we examined a most excellent set of missives from Jeffrey P. Snider regarding structural liquidity limitations in the SBS - Shadow Banking System.
On with Part 2, in his OFR working paper Zoltan Pozsar Shadow Banking: The Money View, posits: What does the Federal Reserve’s reverse repo facility mean from the perspective of institutional cash pools?
Unlike retail cash investors, for whom public money is available in the form of currency, institutional cash pools still do not have direct access to public money, as reverse repos are available only to shadow banks, not cash pools.
That said, reverse repos mean that the shadow money claims that cash pools keep the bulk of their cash balances in are now backed — at least in part — by something of much higher quality than anything that was available before: the gradual increase in the size of the Federal Reserve’s reverse repo facility with individual shadow bank counterparties means a gradual increase in the share of shadow money claims backed by the safest of safe assets — the liabilities of the Federal Reserve.
It is also worth emphasizing that reverse repos, if permanent, could become the basis of a liquidity-requirement regime for shadow banks. Much like banks have a minimum reserve requirement against the demand deposits they issue, minimum reverse repo balances could become the equivalent of minimum reserve requirements for shadow banks against the overnight repo and constant NAV liabilities they issue.
From Pozsar: The graph above shows that as of the end of the third quarter of 2013, the U.S. dollar lending and borrowing by banks outside the U.S. amounted to about $9 trillion and nearly $8 trillion, respectively.
We know how much, but the great unknown is the composition of the offshore US dollar banking.
But beyond that, we have no information about whether these dollar assets were loans or portfolios of bonds. Similarly, we do not know if corresponding dollar liabilities were long-term (such as bank bonds) or short-term, and if short-term, whether they were deposits, commercial paper, repos (done in Europe) or FX swaps.
Pozsar estimates: the size of the core of the shadow banking system was just under $5 trillion as of the third quarter of 2013, down from a peak of over $8 trillion as of the second quarter of 2008.
Pozsar assumes: the estimates measure the net supply of money and money-like claims issued by dealers and money funds at the core of the system and disregards all forms of capital market lending not funded in the money market.
Initial measures of the system were gross, not netting for holdings between intermediaries, and included all forms of securitized credit regardless of whether they were funded in the money market or not, which inflated aggregate measures further.
Banks do more than just lending. They also issue money claims. By extension, if lending without money creation does not qualify as banking, neither should capital market lending without money market funding qualify as shadow banking.
Pozsar's market dynamics: Dealers are not real economy lenders, but intermediaries between cash and risk PMs who search for the symmetrical extremes of safety and yield.
Dealers provide collateralized safe assets in the form of repos to cash PMs on the liability side of their balance sheet, and leverage via collateralized cash loans in the form of reverse repos to risk PMs on the asset side of their balance sheet.
This helps cash PMs safekeep growing cash pools and risk PMs provide returns that are in excess of the real economy’s growth potential.
As a result of these collateralized transactions, bonds are becoming more and more valuable as collateral and bond portfolios are becoming more and more leveraged across the financial ecosystem.
Pozsar's version of the new paradigm: Today we have a different class of savers (cash PMs versus retail depositors), a different class of borrowers (risk PMs to enhance investment returns via financial leverage versus ultimate borrowers to enhance their ability to spend via loans) and a different class of intermediaries (dealers who do securities financing versus banks that finance the economy directly via loans) to whom discount window access and deposit insurance do not apply.
The twin pillars of the official safety net were erected around traditional, deposit-funded banks to address retail runs. In contrast, the 2007-08 crisis was sparked by institutional runs: cash PMs ran on dealers and dealers ran on risk PMs. But importantly, beyond the institutional façade of the ecosystem it is ultimately retail wealth and promises that are at stake.
On with Part 2, in his OFR working paper Zoltan Pozsar Shadow Banking: The Money View, posits: What does the Federal Reserve’s reverse repo facility mean from the perspective of institutional cash pools?
Unlike retail cash investors, for whom public money is available in the form of currency, institutional cash pools still do not have direct access to public money, as reverse repos are available only to shadow banks, not cash pools.
That said, reverse repos mean that the shadow money claims that cash pools keep the bulk of their cash balances in are now backed — at least in part — by something of much higher quality than anything that was available before: the gradual increase in the size of the Federal Reserve’s reverse repo facility with individual shadow bank counterparties means a gradual increase in the share of shadow money claims backed by the safest of safe assets — the liabilities of the Federal Reserve.
It is also worth emphasizing that reverse repos, if permanent, could become the basis of a liquidity-requirement regime for shadow banks. Much like banks have a minimum reserve requirement against the demand deposits they issue, minimum reverse repo balances could become the equivalent of minimum reserve requirements for shadow banks against the overnight repo and constant NAV liabilities they issue.
We know how much, but the great unknown is the composition of the offshore US dollar banking.
But beyond that, we have no information about whether these dollar assets were loans or portfolios of bonds. Similarly, we do not know if corresponding dollar liabilities were long-term (such as bank bonds) or short-term, and if short-term, whether they were deposits, commercial paper, repos (done in Europe) or FX swaps.
Pozsar estimates: the size of the core of the shadow banking system was just under $5 trillion as of the third quarter of 2013, down from a peak of over $8 trillion as of the second quarter of 2008.
Pozsar assumes: the estimates measure the net supply of money and money-like claims issued by dealers and money funds at the core of the system and disregards all forms of capital market lending not funded in the money market.
Initial measures of the system were gross, not netting for holdings between intermediaries, and included all forms of securitized credit regardless of whether they were funded in the money market or not, which inflated aggregate measures further.
Banks do more than just lending. They also issue money claims. By extension, if lending without money creation does not qualify as banking, neither should capital market lending without money market funding qualify as shadow banking.
Pozsar's market dynamics: Dealers are not real economy lenders, but intermediaries between cash and risk PMs who search for the symmetrical extremes of safety and yield.
Dealers provide collateralized safe assets in the form of repos to cash PMs on the liability side of their balance sheet, and leverage via collateralized cash loans in the form of reverse repos to risk PMs on the asset side of their balance sheet.
This helps cash PMs safekeep growing cash pools and risk PMs provide returns that are in excess of the real economy’s growth potential.
As a result of these collateralized transactions, bonds are becoming more and more valuable as collateral and bond portfolios are becoming more and more leveraged across the financial ecosystem.
Pozsar's version of the new paradigm: Today we have a different class of savers (cash PMs versus retail depositors), a different class of borrowers (risk PMs to enhance investment returns via financial leverage versus ultimate borrowers to enhance their ability to spend via loans) and a different class of intermediaries (dealers who do securities financing versus banks that finance the economy directly via loans) to whom discount window access and deposit insurance do not apply.
The twin pillars of the official safety net were erected around traditional, deposit-funded banks to address retail runs. In contrast, the 2007-08 crisis was sparked by institutional runs: cash PMs ran on dealers and dealers ran on risk PMs. But importantly, beyond the institutional façade of the ecosystem it is ultimately retail wealth and promises that are at stake.
The Nattering One shall muse... in Part 3
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