The Shadow: What’s in a Name – The Malifiscence of Shadow Banking

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Explore:  Banks FSOC Shadow Banking

Long ago and far away, a radio show gave birth to the catchphrase “Who know what evil lurks in the hearts and minds of men?  The Shadow knows.”  I think, although I’m not entirely certain at this point, that the Shadow was a good guy, but deeply misunderstood and viewed with enormous suspicion by more main stream enforcers of right thinking and morality.  Shadows are where bad things happen, where the bad guy hides and jumps out when the teenage starlet inevitably walks into the darkened derelict house, saying in a little voice, “Hello, hello?  Billy, are you there?”  Bad things inevitably ensue.  Shadows are bad.

Okay, what’s this all about?  We need to stop the narrative right now that all financial market participants; funds, specialty finance companies, advisors, BDCs, etc., which are not insured depository institutions (let’s call them non-banks for short) are creatures of the shadows.  Shadows are bad, non-banks are in the shadows…ok, you get the picture.  Our traditional banks, which take deposits guaranteed by the US of A are under the loving and protective wing of the FDIC, the Federal Reserve or the Office of the Comptroller of the Currency (and yes dear Lord, the FSOC).  That makes sense, they take Caesar’s coin and Caesar is entitled to a bit of supervision.  But the non-banks do not; they risk private capital.  That makes a difference.

Words matter, names have power.  This industry lost control of the whole risk retention argument around Dodd Frank when we let the chattering class embrace “skin in the game” as shorthand for the entire debate.  Skin in the game is good.  Not having skin in the game is bad.  The debate got pretty simplistic:  Only bad people argue against skin in the game.  Any thoughtful discussion about whether retaining risk actually achieved risk mitigation and whether and how it would impact capital formation was essentially over.  Game, set, match.

We may be seeing that happen again.  Maybe it’s already too late.  The Economist’s lead story in their May 10 edition was “The Lure of Shadow Banking” with a subheading of “How Safe Is It?”  You can hear our eager politicians now; another opportunity to align with the common man and Main Street; good tub thumping and sound bite material here!  I’m against it (whatever it is)!  Shadows need the disinfectant of bright lights, transparency is the enemy of shadow, regulation is handmaiden of transparency.  Ergo, let’s champion more comprehensive regulation!

As Charlie Brown would say, “We are doomed.”  We have seen how poorly much of our newest regulatory edifice brought to us by Dodd-Frank aligns with the needs of capital formation and the realities of risk mitigation.  We have witnessed with frightening regularity the consequences of populist fueled regulatory initiatives.  We have seen how impervious the enablers of the comprehensive regulatory state, armed in their virtue, are to evidence inconsistent with the verity that new regulations are an unalloyed good.

We simply can’t afford to go gently into the night while the non-banking financial sector is crushed with a regulatory burden disproportionate to the issues and badly designed to fix ill understood perceived abuse.

Look, there are plenty of legitimate issues and concerns as funds, asset managers, investment advisors and specially financed companies of all ilks, engage in commerce.  Those are surely things to talk about.  In this day and age, one must assume that as trillions of dollars of financial activity pass through this sector of the financial marketplace, these players and that commerce will attract some governmental attention, and that’s perhaps not all bad.  But let’s not foreclose an intelligent and reasoned debate over risk and the proper scope of governmental action by handing those with a strong predilection to regulate who will never see a regulation that they did not like catchy verbal sticks to help beat us around the head and ears in the upcoming debate.  Shadow banking just sounds nefarious.  It just does.  Go tell your Aunt May that you are a proud participant in the shadow banking market and she’ll probably call the Attorney General.  Words matter.  We cannot have the debate dragged by its populace nose into a place where serious discussions becomes neigh unto impossible and thoughtful observers are left to play catch up as a fortress like received wisdom that shadow bankers need keepers sweeps the day.  Time to Act.

 

Topics:  Banks, FSOC, Shadow Banking

Published In: Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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