Bill Gross: Our 'Shadow' Banking System Needs a Fed Bailout

From PIMCO Managing Director Bill Gross's monthly market commentary for January 2008:

Our modern shadow banking system 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. Financial derivatives of all descriptions are involved but credit default swaps [CDS] are perhaps the most egregious offenders. While margin does flow periodically to balance both party’s accounts, the conduits that hold CDS contracts are in effect non-regulated banks, much like their hedge fund brethren, with no requirements to hold reserves against a significant "black swan" run that might break them. Jimmy Stewart—they hardly knew ye!...

The withdrawal of deposits from our new age shadow banking system has frightening potential consequences because a thinly capitalized banking system is always at risk relative to its more conservative counterpart. Visualize, as does Chart 1, in crude yet understandable form, today’s shadow system versus that of two decades ago.

Pyramid schemes and chain letters collapse because there is no more credit to feed them. As the system of modern day levered shadow finance slows to a crawl, or even contracts at the edges, its ability to systemically fertilize economic growth must be called into question. And as the private shadow banks of the 21st century are found wanting, so then must public finance in the form of lower interest rates and increasing fiscal deficits fill the breach. The Fed will likely reduce Fed funds to 3% by midyear 2008. Congress and the Administration should, but likely won’t, join hands in a tax relief program that benefits low income homeowners.

Comments

[Philly Jim]

We will see tax relief among many other stimulus programs coming out of Washington very soon, some already running.

I think the Fed should stay at 3% and let the recession bleed out the banks who are at fault for the sub-prime mess. There should be strict (IMF style) guidelines mandated by the Fed within any stimulus package offered to the financial community as they are mostly run by pompous morons who spend more time golfing then researching.

I thought America was the land of transparency, these shadow banks and hedge funds needs to lay down their cards and be more thoughtfully regulated.

[Reinko]

Bill, you have my vote!

Although I follow economical and financial news for years I never knew there was an entire shadow system created with all that 'off balance' kind of stuff.

Of course it must not be forbidden for banks to have small amounts of 'off balance' things but the utter size of what we have at present is simply not accaptable.

Yet we are living in times (thanks to Alan Greenspan) where even the central banks have 'off balance' stuff (scroll down in the next Federal Reserve file):

www.federalreserve.gov...

I think it is time to cut the crap becauae as a normal investor you just cannot buy bank stocks because you do not know what you buy... (Just like banks do not want to leand money to each other any more without a reasonable spread.)

[helplessobserver]

Why require a balance sheet if you don't have to keep all of your assets and liabilities on it? Can anyone cite where an asset was moved off the balance sheet to hide it? The keepers of the standards are behaving like the attendees at the big lovein at Woodstock, grab all you can and enjoy.

[NoFate]

Two words Bill ...Moral Hazard.

Why should the taxpayers pay someone else's mortgage?

The entire mortgage industry made horribly bad decisions for 5 years ...let them pay.

Wall Street packaged this garbage and sold it to unknowing buyers as AAA ...let them pay.

Subprime renters got a great 2% deal for a few years ...now let them rent.

Let the free markets do their job. Everyone is a capitalist until there is a recession in their industry and then suddenly they want the government to bail them out.

You are a brilliant CEO and I greatly enjoy your articles ...I know deep down you are not a communist.

[ballsschweaty]

Let me get this straight. You want the Fed to confiscate interest earnings from responsible savers to bail out the banks who lent money to liars and speculators that are now defaulting?

And then you want to borrow more from the Asians to finance a tax cut that we can't afford.

Sounds good Bill. You're a real snake oil salesman.

[chinooking]

asshole