The Shadow Banking System And Why The Fed CAN’T Raise Interest Rates!

By | March 19, 2015

Janet Yellen discussed Fed policy and interest rates yesterday and, with the removal of the word ‘Patient’ from the current Open Market Committee statement, financial markets roared!

Of course when it comes to Fed-speak the removal of one word, in this case ‘patient’, reminds one of another quite famous parsing of words when the phrase ‘it all depends on what you definition of is, is‘ was once uttered.

Concerning the potential for an interest rate hike by the Fed, Ms. Yellen said yesterday, “just because we removed the word ‘patient’ doesn’t mean we’re going to be impatient.

Understand?

According to Zoltan Pozar who was a former top official in the Fed and Treasury Department, due to the leverage present in the shadow banking system, the Fed will be hard-pressed to raise rates by even a paltry .25% any time soon!

Shadow Banking System

First, what is the shadow banking system and why does it matter?

The shadow banking system explained courtesy of Investopedia:

The financial intermediaries involved in facilitating the creation of credit across the global financial system, but whose members are not subject to regulatory oversight. The shadow banking system also refers to unregulated activities by regulated institutions.

Examples of intermediaries not subject to regulation include hedge funds, unlisted derivatives and other unlisted instruments. Examples of unregulated activities by regulated institutions include credit default swaps.

The shadow banking system has escaped regulation primarily because it did not accept traditional bank deposits. As a result, many of the institutions and instruments were able to employ higher market, credit and liquidity risks, and did not have capital requirements commensurate with those risks. Subsequent to the subprime meltdown in 2008, the activities of the shadow banking system came under increasing scrutiny and regulations.

Now, from an article at the must-read financial website Zero Hedge…

Here Is Why The Fed Can’t Hike Rates By Even 0.25%

shadow banking,leverage,interest rates

There was a time when Zoltan Poszar was the most important person at the Fed (and Treasury), because he was likely the only person in the government’s employ who grasped the enormity and complexity of the then-$30 or so trillion US shadow banking system. A quick refresh of his bio from the Institute for New Economic Thinking:

Mr. Pozsar has been deeply involved in the response to the global financial crisis and the ensuing policy debate. He joined the Federal Reserve Bank of New York in August 2008 in charge of market intelligence for securitized credit markets and served as point person on market developments for senior Federal Reserve, U.S. Treasury and White House officials throughout the crisis; played an instrumental role in building the TALF to backstop the ABS market; and pioneered the mapping of the shadow banking system which inspired the FSB’s effort to monitor and regulate shadow banking globally. Prior to Credit Suisse, Mr. Pozsar was a senior adviser to the U.S. Department of the Treasury, where he advised the Office of Debt Management and the Office of Financial Research, and served as Treasury’s liaison to the FSB on matters of financial innovation. He also worked with the Federal Reserve Board on improving the U.S. Flow of Funds Accounts.

While Zoltan is currently working in the private sector at Credit Suisse, he is perhaps best known for laying out, back in 2009, the full topographical map of the US shadow banking system in all its flow of assets (or is that contra-assets when it is a repo) beauty.

Which is also why we bring him up, because in a much welcome follow up to his previous work title “A Macro View of Shadow Banking” which we will discuss further in the coming days because it is not only Zoltan’s shadow banking magnum opus and must read for anyone who wants to get up to speed with all the latest development in the unregulated shadow banking space, but because Poszar also provides perhaps what is the most important chart which explains why the Fed is so very terrified of even the smallest possible incremental rate hike of 0.25%.

Specifically, we look at Poszar’s findings about the implied leverage within the fixed income asset space in America’s just a little levered buyside community. This is what he says…

Read the rest of the article at Zero Hedge here.

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Michael Haltman, President of Hallmark Abstract Service, New York.

HAS is a provider of title insurance in New York State for residential and commercial real estate transactions.

And, for anyone either buying a property or refinancing, remember that although your attorney will likely recommend a title insurance provider you always have the right to choose your own (click here to learn more)!

If you have any questions you can reach Michael by email at mhaltman@hallmarkabstractllc.com.

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