Shadow Banking

There is a Federal Reserve Bank of New York Staff Report titled Shadow Banking.

In contrast to public-sector guarantees of the traditional banking system, prior to the onset of the financial crisis of 2007-2009, the shadow banking system was presumed to be safe due to liquidity and credit puts provided by the private sector. These puts underpinned the perceived risk-free, highly liquid nature of most AAA-rated assets that collateralized credit repos and shadow banks’ liabilities more broadly. However, once private sector put providers’ solvency was questioned, even if solvency was perfectly satisfactory in some cases, the confidence that underpinned the stability of the shadow banking system vanished. The run on the shadow banking system, which began in the summer of 2007 and peaked following the failure of Lehman in September and October 2008, was stabilized only after the creation of a series of official liquidity facilities and credit guarantees that replaced private sector guarantees entirely. In the interim, large portions of the shadow banking system were eroded.

I haven’t had a chance to read all 38 pages of the report, but even the introduction is packed full of useful information. As I learned from the person who suggested this paper to me, it is possible to read this paper and let your preconceived notions completely obscure the lessons of this paper. I don’t know how you could read the excerpt above, and miss the message, but somehow the suggester that I read this managed to do it.

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