Reply #69: Maybe on these sidelines? [View All]

[Tansy_Gold]

The black box economy

http://www.boston.com/bostonglobe/ideas/articles/2008/01/27/the_black_box_economy/

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That something is the immense shadow economy of novel and poorly understood financial instruments created by hedge funds and investment banks over the past decade - a web of extraordinarily complex securities and wagers that has made the world's financial system so opaque and entangled that even many experts confess that they no longer understand how it works.

. . .

The reason this had been happening totally out of sight is not difficult to understand. Banks of all stripes chafe against the restraints that federal and state regulators place on their ability to make money. By cleverly exploiting regulatory loopholes, investment banks created new types of high-risk investments that did not appear on their balance sheets. Safe from the prying eyes of regulators, they allowed banks to dodge the requirement that they keep a certain amount of money in reserve. These reserves are a crucial safety net, but also began to seem like a drag to financiers, money that was just sitting on the sidelines.

. . .

The hiding places for these financial instruments are called conduits. They go by various names - the SIV, or structured investment vehicle, is one that's been in the news a great deal the past few months. These conduits and the various esoteric investments they harbor constitute what Bill Gross, manager of the world's largest bond mutual fund, called a "Frankensteinian levered body of shadow banks" in his January newsletter.

"Our modern shadow banking system," Gross writes, "craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever."

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