Touches upon the shadow banking system and creation of money that goes
besides the regular banking system, related to a few things that I
mentioned about "quasi banks".

http://www.newyorker.com/online/blog...tionality.html

The Rationality of Panic

Between the industrial revolution and the nineteen-thirties, financial
panics occurred regularly in America. Busted speculative bubbles
usually caused them. The asset on which people speculated varied;
often, it had something to do with land, but later, financiers
promoted magical thinking about railroads, too. As the years passed
and the financial system grew more robust, investors could borrow more
money to speculate when certain assets became fashionable and rose in
price, and this additional leverage amplified the booms and busts,
making them more consequential to the real economy. When speculative
investors using enormous amounts of borrowed money produced the stock
market crash of 1929, which was then followed by the failure of
policymakers to respond with needed rescue measures, we had the Great
Depression.

The financial regulatory system that emerged from the New Deal was
meant to protect us from the recurrence of such a catastrophe by
reducing the amount of borrowed money used by major financial
institutions in speculative schemes. It was also meant to create much
greater transparency about the facts underlying stock and bond prices,
so that investors, as a whole, would make more rational decisions and
prevent asset bubbles from getting completely out of hand. That
regulatory system was never designed to banish greed or eliminate
asset bubbles, but it seemed for a long while to moderate the impacts
of speculative fevers on the real economy. Transparency of information
allows markets to work off busted bubbles fairly quickly, and it gives
policymakers the confidence and direction necessary to inject
relieving shots of new money. The tech-stock boom of the
nineteen-nineties, for example, was demonstrably crazy while it was
going on--but it was crazy in plain sight, in the sense that all of
the relevant information about tech-stock prices, including the fact
that many companies with high share prices had no earnings and no
convincing business model, was disclosed to the public.

The tech boom and bust seemed to show that central bankers had learned
how to respond quickly and effectively when bubbles burst. Alan
Greenspan, for one, concluded that it was easier and better for the
economy overall to clean up bubbles after they busted than to
intervene heavily to prevent them from inflating in the first
place. Thus he stood by passively during the housing bubble of the
past few years. This bubble, too, took place in plain sight, in the
sense that by 2006 or so it was clear by historical measures of
housing prices, price-to-rent ratios, and so on, that a bubble had
inflated. If the housing bubble had inflated entirely inside a
transparent, well-regulated financial system, its end might have been
painful, as the tech bust was, but it probably would not have been
unusually consequential. The problem, however, was that the bubble
inflated inside both the old regulatory system and, simultaneously,
inside a new financing system that grew up during the Bush
Administration outside of all government scrutiny.

In the current global panic, unprecedented in fifty years, it is
common to say that the madness of crowds has taken over. It is
certainly true that we should be fearful of fear itself, since panic
has practical economic consequences. Prices, for example, speed down
faster than they would otherwise, which then causes more panicked
selling by leveraged investors. Fearful consumers sit on their
wallets, hurting businesses that might otherwise be healthy, and so
on. At the same time, it is wrong to blame crowds for this current
panic. In many ways investors are reacting rationally to the fact that
critical information about the financial markets--the sort of
information that New Deal-originated regulatory architecture was
supposed to make routinely transparent--is simply not available.

People dont generally panic in the sunshine. They panic in the
dark. And we are in the dark about what assets and liabilities are
truly held in what has been properly labeled the €œshadow banking
system€�--the global aggregation of hedge funds, privately placed
debt securities, and the hedging or insurance contracts known as
credit default swaps. By some accounts, the value of assets held in
this shadow system is as large or larger than then value of the assets
held in the formal, regulated banking system. But nobody really knows,
as there is no transparent market for many of the securities of
concern, and no systematic disclosure of assets and liabilities to
government regulators--not here, not in Europe, and not in Asia,
either.

There are many kinds of uncertainty fueling the current panic. Some of
it is a normal sort of uncertainty, that which typically takes place
when the economy goes from good to bad--for example, nobody knows for
sure how bad the coming recession is going to be, and so it is hard to
price stocks, since the earnings of many companies are headed downward
at an unknown rate. Some of the current uncertainty, however, is not
normal. For example, the market for short-term business-to-business
loans, known as €œcommercial paper,€� has basically ceased
functioning. The Federal Reserve has intervened, but nobody knows how
long it will take to restart such lending, or what damage the seizure
has already done to businesses.

The scariest uncertainties of all involve the unknown liabilities
lurking out there in the shadow banking system. Maybe it will turn out
that these liabilities are not as great as some people fear. On
Tuesday, for example, the International Monetary Fund revised upward
its estimate of the total losses incurred by all global financial
institutions from securities tied to American housing mortgages--the
I.M.F.s new estimate is $1.4 trillion in losses. That sounds like a
lot, but in the scheme of the global economy, whose annual output is
in the neighborhood of $60 trillion, it is not so bad. If the rate of
mortgage defaults does not spike horribly, it might be a manageable
liability.

On the other hand, this week, the New York Federal Reserve began to
convene meetings to try to create transparency and liquidity in the
global market for credit default swaps. These are essentially
unregulated insurance contracts sold privately to financial
institutions to protect them against losses in stocks or bonds. No
government agency regulates credit default swaps. There is no official
information available about the size of the market or the distribution
of liabilities within it.

Maybe most of these contracts are sound, or balanced out in ways that
dont create huge systemic liabilities--lets hope so. Published
estimates of the nominal value of all credit-default-swap contracts in
the world today are in the range of $55 trillion to $60 trillion. So
here is a global private market whose products, combined, have a
nominal value roughly equal to the total size of the world economys
output in a year, and apparently no one in any government knows the
full markets shape, distribution, or true vulnerabilities. Gulp.
Posted by Steve Coll

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It's just a great time to buy stocks, Igor. Hopefully you saw this coming
and went mostly to cash a few months ago.

Grant
** Posted from http://www.teranews.com **

On 2008-10-12, Grant Erwin wrote:
It's just a great time to buy stocks, Igor. Hopefully you saw this coming
and went mostly to cash a few months ago.

It is definitely getting to this point. I do have some cash in various
forms.

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