Jennifer Taub: Before the crisis, the top five financial institutions had assets equivalent to 50Â percent of
GDP. Now let's fast-forward to 2011, three years after the crisis, if you look at the top five institutions that
survived, and their assets are equal to 58Â percent of GDP - October 1, 12
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Jennifer S. Taub is an Associate Professor of Law at the Vermont Law School where she teaches contracts, corporations and securities regulation. Before joining VLS, she taught at the Isenberg School of Management, University of Massachusetts, Amherst. She researches and writes in the area of corporate governance, shareholdersâ€™ rights, bankruptcy, and financial market regulation. Previously, Professor Taub was an Associate General Counsel for Fidelity Investments.
John Weeks is Professor Emeritus and Senior Researcher at the Centre for Development Policy and Research, and Research on Money and Finance Group at the School of Oriental & African Studies at the University of London.
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Baltimore.Our next guest says that shadow banking has surpassed traditional banking, both in scope and significance to the economy and risk to the economy, both in the 2008 crisis and continuing risk. Now joining us to talk about all of this is Jennifer Taub. She's an associate law professor at the Vermont Law School. She also works with SAFER. And she joins us now from Amherst, Massachusetts, where she's at the PERI institute. Thanks for joining us, Jennifer.JENNIFER TAUB, ASSOC. PROF., VERMONT LAW SCHOOL: Thank you for having me here, Paul.JAY: So, first of all, tell us what you mean by shadow banking, and then we'll get into why you think it's so risky.TAUB: Sure. To best describe shadow banking, it's helpful to first define what we're talking about when we talk about traditional banking. And so, by traditional banking, I'm referring to an intermediation or a middleman function. This is where an institution takes in deposits from savers and channels those into loans to either consumers or into the commercial sector. That would be traditional banking.With shadow banking, this intermediaryâthis intermediation function is served by something other than a bank or by a portion of a traditional bank. And what is done there, though, is it's still the channeling of savings into loans, but instead of using deposits that are FDIC-insured, what is used is just other short-term liabilities, very short-term borrowing, very often through what's known as the repo market, which is very short-term, sometimes overnight loans, multitrillions of dollars that can be brought in to these middleman institutions and loaned to investment banks and to others, but just as quickly pulled away, creating incredible vulnerabilities.And it was the run on the shadow banking system that actually brought down both Bear Stearns and Lehman Brothers, as those institutions financed up to half of the assets on their balance sheet in these very short-term, sometimes overnight loans. And when they weren't able to roll over those loans, meaning renew them in the morning, they faced immediate collapse. And I should add that it's not just simply that the institutionâan institution like Bear or Lehman faced collapse, but it was through the shadow banking type liabilities. Instead of one-by-one, you know, consumer deposits, it was through these wholesale, giant loans that can so easily be pulled.The folks on the other side of the loans, of course, were concerned about their own wherewithal. And this is how the domino effects of one institution failing can kind of multiply out.JAY: And they start to not trust each other's books.TAUB: Right. So this is what people meant by a crisis of confidence. It wasn't simply confidence; it was the fact that an institution that's highly leveraged, that has borrowed, let's say, $97 for every $100 in assets, you know, as you can see, with that, if the value of their assets shrink by just by 3Â percent, you would be insolvent. So any hint of trouble with a highly leveraged institution, those lenders to the institution will quickly pull their money.In contrast, with traditional banking, because we have in place deposit insurance, there's less of a threatâit's still there, but less of a threat of the run, because depositors understand that they can be made whole. In addition, with traditional banking, traditional banks are required to put on reserve a certain portion of deposits that they can't use for lending. And they also have access to emergency loans from the Fed. So all these systems were in place to protect traditional banking. With these protections came, though, regulatory oversight, again, the sort of safety and soundness requirements controlling and regulating what banks were supposed to be doing with depositors' liabilities.JAY: And these are the stress tests.TAUB: It's notâit's partiallyâit's the stress tests, and it's the ongoing visits from the banking regulators. And what we had leading up to the financial crisis were vulnerabilities in traditional banking, as well as this massively growing shadow banking system that was serving as a connector between investment banks that were supposed to be able to, under capitalism, either thrive or fail. But because of the interconnections of these banks, the government did this unprecedented intervention, supporting not just traditional banks, but also shadow banks, the giant investment banks, and rescuing them, rescuing other parts of the shadow banking system, such as money market funds, all these institutions that were unregulated and supposed to survive on their own or fail on their own, simply because they were connected to the protected pieces of the system, to the traditional banks, and thereby also connected out into the commercial sector.JAY: So the banks are arguing that they need this kind of flexibility to move massive amounts of capital around the globe because that's the nature of the global economy now. If they can't do this, then the global economy starts to freeze up. So they need the freedom to do this, and they've learnt their lesson, it won't happen again, and we're told there's enough regulation in place that too-big-to-fail can't happen again and life is rosy. Is that your interpretation?TAUB: Well, my interpretation is not so much of that PR spin, that folks who want to keep the system as it is so they can, you know, privatize their profits and socialize their losses (what they will say).I tend to be more evidence-based in how I look at the financial system today. And so it's as ifâyou know, if you went on an exercise regime, you might want to have some metrics before and after the program to see whether your health actually improved. And if you just check on a few of those metrics from before the crisis to after the crisis, it sure looks to me that the same conditions that resulted in these massive interventions and the collapse of the financial system still persist.And what I would look at is this question of too big to fail and too interconnected to fail. And if you look at the preamble to the DoddâFrank Act, which was designed to help reform the financial sector and also protect consumers, if you look at the preamble, one of the focuses is on ending too-big-to-fail banking so that we end taxpayer-funded bailouts.But if you look at the question of size alone, back in right before the crisis, if you look at the top five financial institutions, look at their assets on their balance sheet, these top five had assets equivalent to 50Â percent of GDP. Now let's fast-forward to 2011, three years after the crisis, and the sameâif you look at the top five institutions that survived then, and their assets were equal to 58Â percent of GDP. So we can see that we have larger and more concentrated institutions.In addition, when we look at concentration, take a look at the top ten largest financial firms before the crisis, and the top ten accounted for 55Â percent of all industry assets. In 2011, it was 65Â percent. So in terms of size and concentration, we have bigger institutions. That alone should cause concern.It reminds me of the justification for the massive multi-trillion dollar upfront and backdoor bailouts. You might recall there were many justifications. And one metaphor that I thought was particularly telling was something that Fed Chairman Ben Bernanke said in the summer of 2009. And he said that we had intervened not to help the big firms, butâand this is a quoteâwhen the elephant falls down, all the grass gets crushed as well. And looking back right now, four years after the financial meltdown, I see a lot of crushed grass around me, but I observe that the elephants have gotten much larger.And in addition to that concern about size and concentration is this concern again about leverage, interconnection, and the size of shadow banking. In particular, given that it was the run on repo, the run on these overnight loans at Bear and Lehman that precipitated the crisis and, going back a few years, actually allowed these firms to load up on high-risk, hard-to-price assets, given the problems there, one would think that that would been addressed, and it still has not been. The repo marketsâit's notâthere are different ways to measure the size of these markets, but most recently the Federal Reserve Bank of New York, looking at both the repo market, as well as the reverse repo market, they estimated it's over $5Â trillion. Now, this is again very short-term, sometimes overnight funding. And the Federal Reserve Bank of New York is still quite concerned about the vulnerability there.Also, in terms of leverage, the DoddâFrank Act did not do enough to require the largest institutionsâboth the giant banks as well as the non-bank, the so-called shadow banksâdid notâthe act did not do enough to require them to have cushions to absorb their own losses. And whereâthough the banks will say, we are less leveraged now than we were before, the law doesn't require substantially more equity capital than it did before. It's still about 4Â percent. And that will ramp up. They're required to have more of a cushion, to the extent they're considered to be riskier institutions. But we have not really hadâwe have not had a single non-bank financial institution designated as systemically important. So thereâwe still have a whole host of shadow banks, including hedge funds and the like, that can operate at giant sizes with extreme leverage and create vulnerabilities should they fail.JAY: Well, in part two of this interview, let's go further and we'll talk about: are these institutions still too big to fail? And is the risk any less than it was in 2008? So please join us for part two of our interview with Jennifer Taub.
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