Wall Street's "SHADOW MARKET", what the heck is it?

[toomuchtime_]

Why would a bank be required to have a higher reserve for them while a financial institution would not?

Is this an unnecessary rule for banks that SHOULD NOT HAVE BEEN there? And if you say no, it should have been there for the regulated banks because of "so and so reasons" or because of "XYZ" reasons then why would this have not applied to our financial institutions which in some cases, were even larger than the banks themselves?

p.s. please try to put this at a kindergartner's level so i can try to understand it...

The reserve requirements are there to assure depositors will have ready access to their money under ordinary, or even slightly extraordinary, circumstances. Financial institutions such as investment banks or hedge funds do not have depositors so they are not subject to this requirement.

 

[Care4all]

Why would a bank be required to have a higher reserve for them while a financial institution would not?

Is this an unnecessary rule for banks that SHOULD NOT HAVE BEEN there? And if you say no, it should have been there for the regulated banks because of "so and so reasons" or because of "XYZ" reasons then why would this have not applied to our financial institutions which in some cases, were even larger than the banks themselves?

p.s. please try to put this at a kindergartner's level so i can try to understand it...

The reserve requirements are there to assure depositors will have ready access to their money under ordinary, or even slightly extraordinary, circumstances. Financial institutions such as investment banks or hedge funds do not have depositors so they are not subject to this requirement.

Then where do they get their money from...TMT?

care

 

[Toro]

No, you are confused. First of all, the shadow financial system refers to non banks entities such as hedge funds or the financial arms of corporations such as GMAC, not to these kinds of investments by Citi or other banks. The SIV's were on the corporate balance sheets but were not on the banking balance sheets because they had nothing to do with the banking functions of Citi.

When the market for SIV's died and financing for them became hard to obtain, Citi could have sold them at a steep loss for the corporation without effecting the bank's balance sheets at all, but since their long term value was still intact, Citi chose to bring them on to the bank's balance sheets, in effect having the bank provide the financing for them that was no longer available elsewhere, thus increasing the bank's reserve requirements and reducing the money it had to lend to other borrowers. This was done, not because Citi had to do it, but because it was trying to preserve the long term profits for the corporation at the expense of current profits it might have made if the money had been used for other loans.

There is nothing secretive or deceptive or "shadowy" about any of this if you just remember that the corporation and the bank maintain separate balance sheets because they are distinct entities.

I've never said nor thought anything was deceptive or shadowy about the shadow banking system. Rather, it was terminology I first heard from Paul McCauley at PIMCO on CNBC one morning and the term stuck - which I have always referred to as anything outside of the regulated banking system, even those affiliated with the banks since many investors were unaware of their existence, whether or not that was actually correct.

They could have named it the "non-regulated banking system" but that's not as catchy.

 

[toomuchtime_]

Why would a bank be required to have a higher reserve for them while a financial institution would not?

Is this an unnecessary rule for banks that SHOULD NOT HAVE BEEN there? And if you say no, it should have been there for the regulated banks because of "so and so reasons" or because of "XYZ" reasons then why would this have not applied to our financial institutions which in some cases, were even larger than the banks themselves?

p.s. please try to put this at a kindergartner's level so i can try to understand it...

The reserve requirements are there to assure depositors will have ready access to their money under ordinary, or even slightly extraordinary, circumstances. Financial institutions such as investment banks or hedge funds do not have depositors so they are not subject to this requirement.

Then where do they get their money from...TMT?

care

Hedge funds get their money from investors who buy shares in the hedge funds, much as you might buy shares in mutual funds. Investment banks can get their money from shareholders or loans or sometimes they act as managers or agents for investors' money. It was mostly investment banks that either bought up mortgages and then bundled them and sold debt backed securities based on them or acted as agents for commercial banks or mortgage companies that wanted to do the same. Financial arms of corporations like GMAC or Ford Credit Corp. get most of their money from selling bonds and debt backed securities. I'm probably leaving out some other sources of capital.

 

[Care4all]

The reserve requirements are there to assure depositors will have ready access to their money under ordinary, or even slightly extraordinary, circumstances. Financial institutions such as investment banks or hedge funds do not have depositors so they are not subject to this requirement.

Then where do they get their money from...TMT?

care

Hedge funds get their money from investors who buy shares in the hedge funds, much as you might buy shares in mutual funds. Investment banks can get their money from shareholders or loans or sometimes they act as managers or agents for investors' money. It was mostly investment banks that either bought up mortgages and then bundled them and sold debt backed securities based on them or acted as agents for commercial banks or mortgage companies that wanted to do the same. Financial arms of corporations like GMAC or Ford Credit Corp. get most of their money from selling bonds and debt backed securities. I'm probably leaving out some other sources of capital.

where is the majority of the bailout money going, the investment banks who took these major risks with less in reserves?

and why is it okay again for them to have less in reserves AND wasn;t THAT one of the real problems?

 

[toomuchtime_]

Then where do they get their money from...TMT?

care

Hedge funds get their money from investors who buy shares in the hedge funds, much as you might buy shares in mutual funds. Investment banks can get their money from shareholders or loans or sometimes they act as managers or agents for investors' money. It was mostly investment banks that either bought up mortgages and then bundled them and sold debt backed securities based on them or acted as agents for commercial banks or mortgage companies that wanted to do the same. Financial arms of corporations like GMAC or Ford Credit Corp. get most of their money from selling bonds and debt backed securities. I'm probably leaving out some other sources of capital.

where is the majority of the bailout money going, the investment banks who took these major risks with less in reserves?

and why is it okay again for them to have less in reserves AND wasn;t THAT one of the real problems?

Investment banks don't have depositors to protect so they don't need much in the way of reserves, and they are more complex organizations than commercial banks are. In some cases they are operating with shareholders' money and in many cases they are acting as agents for other banks or other corporations. There aren't really any pure investment banks left. They've all been bought by commercial banks or become commercial banks themselves. Once they are associated with commercial banks, their operations are subject to many of the same regulations commercial banks have to deal with. In particular, this means they cannot leverage their assets as far as they had in the past, and that will reduce some of the risk of a system wide collapse in the future, but it will also mean we will have less credit available to finance future growth.

The problem with reserves had to do with commercial banks. The Fed and the FDIC had allowed banks to use debt backed securities to satisfy their legal reserve requirements. At the time these securities were rated AAA and there was a robust market for them, so while it should have seemed risky, it did make some sort of sense. When the market for these securities dried up in 2006, the mark to market rule was applied to radically reduce the value of these securities and this left the banks short of their required reserves. This left some banks with insufficient or nearly insufficient reserve funds to cover their outstanding loans, and most of the first half of the TARP money went to bolster the reserves of these banks to keep them from becoming insolvent.

Had the Fed and FDIC not allowed the banks to use the debt backed securities as reserves, they would not have owned so many of them and when the market for them dried up, it would not have effected bank reserves and we would not have had to bail out the banks to keep them from becoming insolvent.