We're here with Carl Tannenbaum, Chief Economist of Northern Trust, to talk about shadow banking.
So shadow banking was identified as a contributor to the financial crisis of 2008. Why is there so much continuing attention to the world of shadow banking?
First, let me define what shadow banking is. 50 years ago, people invested with banks, people got their loans from banks, and it was a very well-contained system. But starting back then, you started to see people investing in instruments outside of the banking system. And many borrowers were getting their credit from outside the banking system.
Simple examples of this, Doug, are money market mutual funds or mortgage-backed securities-- things that are sold directly from borrowers to investors. And now that tends to dominate the credit industry.
The reason it got called shadow banking was because it was much harder to keep track of than when everything was on bank balance sheets. And what you don't know ended up being something that ended up hurting us.
So has the regulation that came about after 2008 addressed the risks of shadow banking?
Yes and no. In the yes part, a lot of the structures that were designed to create shadows have been brought back into the light. A lot of the conduits or special purpose vehicles, terms from the 2008 crisis, have been eliminated. Banks have taking those back home to their balance sheets, where they can be watched very closely.
Conversely, though, there are some new vehicles, like exchange-traded funds or other products, that are now looking more and more shadowy. And I think there's still lingering concern with 2008, not that long ago, that those new structures could cause us similar kinds of problems.
So what other new structures are attracting attention?
So there are certainly now pools where lenders and borrowers can find each other on the internet. Peer to peer lending is one example. In addition, there are funds that asset managers are generating where they will buy loans that are made to small companies or even to people, and sell them directly to investors. Certainly, this is helpful to the flow of capital. But again, it's hard to keep track of, and it may not be as stable if we ever get into another crisis.
So how can we safeguard the financial system against these newer risks?
I think we need to remember that the financial system is never going to be completely immune from risk. In fact, risk is what makes the financial system work. Nonetheless, I think the sort of enhanced reporting so that we know what's going on in these new structures, as well as a little bit more monitoring to ensure that there's appropriate capital and liquidity in the system, would help us feel comfortable that if a meltdown ever occurred, it wouldn't go to the depths that we saw in the last crisis.
Thanks so much.