Shadow Bank Interview Up at The Atlantic Business

We are live at The Atlantic Business! An interview I did with Perry Mehrling about shadow banks has just been posted. Please do check it out, and maybe even read it twice – there is a lot to think about there. I’m very happy with how it turned out.

When I last talked about the Shadow Banks, I came up with a working definition: “Your local shadow bank took in money in the repo market as deposits, and used senior tranches of debt as the collateral, and had no market maker of last resort.” I felt I was onto some interesting stuff, but wanted to look further than the Gary Gorton paper that initiated this inquiry for me. Several very smart people lead me to Professor Perry Mehrling, an economist at Barnard College, Columbia University.

Mehrling has a fantastic paper, The Global Credit Crisis, and Policy Response, about the shadow banks and their role in the current crisis. It’s very accessible to a general reader with an interest in the subject matter and just a bit of background knowledge and by far the best explanation of this part of the crisis; I highly encourage you to read it before or after tackling the interview. He also has a video of him presenting the paper, as well as a webpage full of relevant papers and editorals. Check it out.

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2 Responses to Shadow Bank Interview Up at The Atlantic Business

  1. Taunter says:

    The analogy to earthquake insurance is curious, because of course the answer after some reflection is that you shouldn’t insure earthquakes at all – the risk cannot be diversified away.

    A few years ago I was in India and I met with the leader of an NGO who was organizing community based monsoon insurance. It was essentially a food bank that farmers could draw from in the event their crop failed due to a lousy monsoon. It met all the important buzzwords – “local,” “community”, “empower”, “women”, “indigenous”, etc. I offended the guy greatly by telling him it wouldn’t work; indeed, worse, it couldn’t work. The very refusal to diversify geographically meant that when one guy’s crop failed, everyone’s crop failed.

    We had a fairly tense exchange – I was told I didn’t appreciate India’s unique culture – and I asked if the program had encountered any problems during its history. Seemingly oblivious to our source of disagreement, the guy said the program had failed twice…”but those were bad monsoons.”

    There is something in the human brain that refuses to process correlation. Given the interconnectedness of the financial market, I am more sympathetic to a straightforward ban on CDS than it would appear you or the professor are. I recognize that the system COULD work, but I also think that it deals in tail risk that are, at least today, virtually impossible to model. Perhaps in a very different model, where all CDS were exchange traded, could not exceed the notional amount of the underlying debt, and required full posting of unencumbered collateral, the product could work safely…but in that case the friction costs would likely overwhelm the utility of the product.

  2. q says:

    the best insurance would be to have broad experience dealing with financial crises. of course that means having them pretty often.

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