Financial castles of sand

sand castle

The Financial Times has a quite understandable, informative article about the collapsing shadow banking system and how it is impacting real banks and the financial world at large.

How crazy did it get?

Satyajit Das, an author and derivatives industry expert, cites an example where just $10m of real, unlevered hedge fund money supports an $850m mortgage-backed deal. This means $1 of real money is being used to create $85 of mortgage lending.

Little of this was regulated, because CDOs and SIVs are not real banks. While this allowed them to do insane things, it also means that, unlike actual banks, they have no lender of last resort to bail them out.

But they were borrowing from real banks, who now will suffer real pain too.

Most of these vehicles, and the shadow banking sector as a whole, is supported by back-up liquidity lines with “real” banks – promises to lend money that bankers never imagined they would have to deliver on.

The rot is not just in the US. Municipalities in Australia may sue Lehman Brothers after CDOs Lehman sold to them are now worth pennies on the dollar. And a Canadian bail out by a consortium of banks has failed before it got started, just like the US effort (deemed by some as the “Save Citi plan”) also has.

Not only were municipalities buying this now toxic waste as supposedly safe investments, so were pension funds and enhanced money markets, maybe your pension fund…

One comment

  1. While there are obvious differences, the way you put it (and also Jim Kunstler) makes it sound a lot like the unsecured margin-tanking currency combination that began the worldwide Great Depression. That’s a bit frightening.

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