Taub on Shadow Banking

Jennifer S. Taub has updated “What We Don’t Talk About When We Talk About Banking” on SSRN.  Here is the abstract:

The run on the shadow banking system in 2008 is routinely identified as the event that transformed the nonprime mortgage securities meltdown into a full-blown Global Financial Crisis. Yet, the components of this shadow sector have not been brought into the light let alone under adequate regulatory supervision. The government-initiated reform measures enacted to date lack consistency and cohesion. Too little attention has been paid to how the varied pieces of this system interconnect with each other and with “real” banking. For example, the multi-trillion dollar repurchase agreement (“repo”) market was ground zero for the sudden, severe withdrawal of liquidity from the banking system in the United States. Yet little has been done to address the dependence upon this short-term, often overnight funding market. Conversely, some shadow players like money market mutual funds, (MMFs) that were already subject to heavy structural controls, have been further regulated. While these new rules were designed to strengthen the funds, making them less prone to runs by their own investors, these same changes may create even more instability and risk for bank and shadow bank counterparties who depend upon them for short-term financing. Additionally, with regard to some of the most risky “nonbank” financial firms, such as hedge funds, the regulatory reform measures to date have been flimsy at best. Accordingly, this chapter first will describe what is meant by “shadow banking,” and the role it played in the financial crisis. Next, it will highlight two key components of shadow banking system: MMFs and the repo market, including the regulatory reforms accomplished to date and proposals being studied. And, finally it will present alternative suggestions for further reform.