[SOUND] So let me just get started then with the new banking shadow banking, central banking and, and the future of global finance. so I'm going to be trying today to draw together, the last couple lectures we did forwards and futures. Okay, and, and we know about foreign exchange swaps, we know about interest rate swaps, we know about credit default swaps all that stuff. Today, we're going to draw it all together and talk about the consequences of all of this for banking. so we're drawing together all the pieces of the puzzle that we've been building in the last, in the last two weeks. Actually, the last, last semester. and in, in, in this lecture, and this is going to be the last one, really about banking the next one, that you'll going to have on Monday is about Economics. So it's going to take all of the stuff we've learned and connect it to the economics that you know, to the, the standard Macro that you know, so this is in a way the last one about, about banking. And, I start with this slide here, I think I've shown you this before, this is the famous shadow banking diagram that my friend Sultan Posar created when he was at the New York Fed. that is showing all the different facil, the way in which, loans on this side, okay, were, were funded by deposits on this side. They're securitized, they're sliced and diced, there's various stages, seven stages here, until they're funded by deposits and money market mutual funds here, and so forth, and here wrapped, this blue thing here, this U-shaped blue thing, that's the Fed, wrapping it's encompassing arms around the shadow banking system. and here in these tight that's too small. This is all the different facilities, liquidity facilities that are created during the, during the crisis to, to save the system. this is really meant to just be a stunning image that shows you that we're not in this world [LAUGH] any, anymore. Traditional banking, this is sort of modern banking. A lot of this stuff has fallen apart. That's what the cris, crisis did. But I don't think it means that shadow banking is, is in the past. I think it just means that we've learned that a certain way of putting this together this, this is a sort of rube goldberg machine. Right? You know, it's very complicated. Okay. But it doesn't have to be that complicated. it's that complicated because it was built little piece by little piece and every piece is built on another one. so I think the next stage is going to be a lot simpler but we need to understand, what is the underlying logic of that. And that's what I'm going to try to talk about today. What is the underlying logic of shadow banking? Why is shadow banking in our future given how, how desperately it is, it has failed us. So there, there lets start with this shadow banking is let's just say market based credit I'm showing down here in the bottom this is a traditional bank so that's like the one I am showing, we are showing on the board here, the Jimmy Stewart bank. where the bank is just taking deposits in from retail deposits for members of the community. And it's making loans, retail loans to members of the community. It's holding reserves, cash reserves. And it has a capital buffer here. so that's the liquidity and the solvency. backstop. And if you run out of liquidity or you run out of solvency there's a further backstop. in the government, the federal reserve bank here, is liquidity backstop, and the FDIC is sort of capital backstop for the traditional bank. [COUGH] This is the image that most people, probably most people in this room still, even after this course, have in your mind when you say bank. Okay, it's, it's something like, like this. And so, one way to enter into thinking about what is a shadow bank is through that. I will show you later that it, it is misleading way to enter into it, but let's start there because that's where, where we are in our, in our heads. and so I'm showing up here the shadow banking system. A stylized version of that, of Zoltan's diagram, where you have the loans over here. Actually, I'm showing them already securitized. RMBS means residential mortgage-backed security, here, and I'm showing the depositors over here. And there's various stages. I have just three stages, three entities, not seven. so that you're cau, you're tranching these. You're dividing these residential mortgage bank securities into high quality tranche, mid tranche, low tranche. So these risks, risk tranches, and the high tranche is, is held by a shadow bank. and is used as collateral for money market funding I'm showing there repurchase agreement funding, RP funding. And that repurse agreement is bought by a money market mutual fund that is using it as an asset to fund uh,deposits. I'm putting deposits in quote there The different, one of the differences between the shadow banking system, or rather the market based credit system and the, and the traditional banking system, is that it's largely a wholesale system, okay. That these, that these deposits here, these are institutional deposits, they're deposits of, of, of pension funds, of foreign central banks. you know, where a small deposit might be $10 million, or something. You know, corporations, something like, it's not retail. It's not, It's not you know, Grandma here, okay, with her, with her passbook saving account. these are, these are wholesale deposits. This is a wholesale money market here and these are not individual loans on the other side, they're securities, they're packages of loans. You know, they're, it's, this is the capital market we're, we're talking about here. Nonetheless, it's also maybe not local. This could also be abroad. A lot of this was abroad, okay, in, in, in Europe and there's no particular reason that this is a physical institution you know sitting, sitting on Main Street in some small town in Indiana, okay? this is sitting on some computer, okay, somewhere. maybe even off shore became an island somewhere. [COUGH] even so we recognize, if we look at shadow banking, market based credit through the lens of traditional banking it looks kind of similar, right. That ultimately it's deposits that are funding loans. The big difference that this slide is meant to bring to your attention, is that the backstop. The, the government backstop is not anywhere to be seen here. You know? The federal reserve is not, is not having any liquidity responsibility. Nor is there an FDIC equivalent. The government is not directly backstopping any of this. a lot of it, as I say, was offshore, and so the Fed and the FDIC just said that well, good riddance. Risk, risk that's offshore is not our problem. we'll see in what way it became their, their problem. but this is, this is a, beginning.
