PIMCO's McCulley Discusses The Ticking $3 Trillion Shadow Banking Time Bomb, Defends The Fed As Head Regulator

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Wed, 05/12/2010 - 15:59 | 347299 SDRII
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Office of Debt Management Treasury Borrowing Advisory Committee Members



Matthew E. Zames
Managing Director
JP Morgan Chase
383 Madison Avenue
New York, NY 10179

Ashok Varadhan
Managing Director
Goldman, Sachs & Co.
200 West Street
New York, NY 10282

Scott Amero
CIO of Fixed Income
55 East 52nd Street
New York, NY 100552

Keith T. Anderson
Chief Investment Officer
Soros Fund Management
888 Seventh Avenue
New York, NY 10106

Richard A. Axilrod
Managing Director
Moore Capital Management, Inc.
1251 Avenue of the Americas
New York, NY 10020

Ian G. Banwell
Round Table IMC
214 North Tryon Street, Suite 3000
Charlotte, NC 28202

Fred Brettschneider
Head of Global Markets, Americas
Deutsche Bank
60 Wall Street
New York, NY 10028

Paul McCulley
Managing Director
840 Newport Centre Drive
Newport Beach, CA 92660



Wed, 05/12/2010 - 23:31 | 348339 bulldung
bulldung's picture

This article expands my frame of reference of finance like many ZH posts. I should feel good about learning something for my time. But actually the emotion I am experiencing right now is disgust. Why? The author invokes the elitest framework that the origin of the money used to backstop the losses was from the Fed. I see it differently. The labor that produces the tax dollars that will ultimately pay back the treasury/Fed will be the middle class worker of the future, yours and my kids. In the short run the devaluation by inflation or default may harm todays middle class. Who are the greatest beneficiaries of the Fed backstop/bailout I ask? Those who already have large holdings in their retirement funds or are very wealthy, particularly those with large holdings in the "big five". This shift of funds at par for toxic assets[full payment from an insolvent AIG of  CDS on CDOs with TARP funds to Goldman et al] was robbery. Eventually the victims of the theft will wake up. The Fed is not the Bank of Dad because it doesn't earn the money, I know how that feels because I earn for two college students and two teens in high school , 39%Fed tax+ 9% local sales tax+ much insurance to backstop my risks. I feel the weariness when money is spent. The Fed feels nothing but hubris. 

I agree with the historical cause and effect in slowing the run described by Mr. McCulley, but the shifting of the losses to the American taxpayer was wrong and the Fed should not be exalted for doing so.

Rant complete.

Thu, 05/13/2010 - 03:18 | 348528 chumbawamba
chumbawamba's picture

Your rant is righteous.

I am Chumbawamba.

Thu, 05/13/2010 - 00:02 | 348381 tom a taxpayer
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SDRII - Every one of the Treasury Advisory Committee a man of honor.

Every one a selfless servant of the public interest.

Every one without a conflict of interest.

Every one puts Main Street above Wall Street.

Every one deserving of the Nobel Prize for service to humanity.

Every one doing God's work.

Wed, 05/12/2010 - 16:00 | 347301 jesusonline
jesusonline's picture

Thank you for the read.

Wed, 05/12/2010 - 16:02 | 347305 Jim B
Jim B's picture

Someday when this Fiat crap blows up, we will have listen to the "experts" tell everyone that it is obvious that you couldn't print unlimited $$$$.  Congress will hold hearings to blame someone else, I haven't figured out who will be the scapegoat yet? LOL

Wed, 05/12/2010 - 16:11 | 347338 JiangxiDad
JiangxiDad's picture

Wow. There will still be a Congress?

Wed, 05/12/2010 - 20:37 | 348026 Papasmurf
Papasmurf's picture

They will be hiding in bunkers. 

Wed, 05/12/2010 - 16:14 | 347345 economicmorphine
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We never have to listen to the experts.  Ignoring the experts is the most empowering thing one can do for him or herself. 

Wed, 05/12/2010 - 17:16 | 347506 Carl Spackler
Carl Spackler's picture

Hence, the reason why American Idol is so popular?!

Wed, 05/12/2010 - 16:07 | 347323 deadparrot
deadparrot's picture

Paul, could you stick your nose up Ben's a$$ a little farther please? I can still see your ears.

Wed, 05/12/2010 - 16:51 | 347437 Jim B
Jim B's picture


Wed, 05/12/2010 - 16:08 | 347326 Oracle of Kypseli
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the only question is how intensely it will self-feed as its assets and liabilities are put back onto the balance sheet of the conventional banking system.” - Paul McCulley

The answer is....the fed will never allow these to go back into the balance sheets until the gradual and study (hyper)inflation takes care of things. Or this is what they are hoping.

History and experience tells us that those little butterflies flying in different parts of the world can trigger the landslide. Others use aquatic birds to express the same event.

Wed, 05/12/2010 - 16:10 | 347328 carbonmutant
carbonmutant's picture

"... A banking system is solvent only if it is believed by the public to be a going concern. By definition, if the public’s ex-post demand for liquidity at par proves to be equal to its ex-ante demand, a banking system is insolvent because a banking system ends up, at its core, promising something it cannot deliver."

This is what the smoke and mirrors from our current governments is all about.. This is what an audit of the FED would reveal.

Wed, 05/12/2010 - 16:13 | 347341 lbrecken
lbrecken's picture

What is sad about Zerohedge I have not heard a peep on the successful Portugues bond offering......where is the fair and balanced?

Wed, 05/12/2010 - 16:15 | 347348 SDRII
SDRII's picture

you must have missed the headline this am that the ECB was in the amrket buying portugal, span, ireland and greek bonds too

Wed, 05/12/2010 - 16:43 | 347408 Ned Zeppelin
Ned Zeppelin's picture

Hey, congrats and let me give a sweet shout out and overdue props to Portugal on that bond offering! Nice job, guys!


(How's zat?)

Thu, 05/13/2010 - 04:26 | 348568 timhinchliff
timhinchliff's picture

Dude I love ZeroHedge and very strongly believe that their view is the most correct view I have come across. That said they aren't remotely balanced and I know by devouring ZH all the time I am probably giving myself a serious dose of confirmation bias. You want balanced go to the BBC, although there analysis won't be anywhere near as informed as ZH.

As for the PIMPCO talk above, what the crap? This guy seems to hold in adulation one of the fathers of efficient market hyposthesis, otherwise known as a complete load of bullshit that does not even remotely follow real world observation.

Random certainty and history brothers and bitches that's how one looks at the market. It ain't different this time just like it wasn't the last time.

Thu, 05/13/2010 - 06:21 | 348596 mephisto
mephisto's picture

1. Portugal is broke.

2. Portugal issues ECB guaranteeed bond, receives EUR, from buyers including the ECB.

4. Portugal pays EUR received into 500Bn ECB guarantee facility.

5. Portugal is broke.

rinse, repeat, restore confidence.

Wed, 05/12/2010 - 16:16 | 347349 pan-the-ist
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Paging Mako... Mako?  You there?

Wed, 05/12/2010 - 16:26 | 347369 Wyndtunnel
Wyndtunnel's picture

Dad. Can I borrow $1 trillion dollars to buy cocaine?

Wed, 05/12/2010 - 16:31 | 347377 Internet Tough Guy
Internet Tough Guy's picture

He will remember the days in 2007 when there was some stupid CDO problem; the real fireworks haven't even started.

Ordinary people will remember the day their currency got devalued, their bank closed, their job vanished, their standard of living got repo'd, they couldn't buy food.

All those days are coming.


Wed, 05/12/2010 - 16:37 | 347394 cossack55
cossack55's picture

the sooner the better!!!!!

Wed, 05/12/2010 - 17:08 | 347483 Votewithabullet
Votewithabullet's picture

"all those days are coming" Just like hay-soos, right around the corner, any day now.

Wed, 05/12/2010 - 17:09 | 347486 jdrose1985
jdrose1985's picture

they couldn't buy food.

this began worrying me until I bought 4 of these today...


I keep wondering if I'm paranoid. Hopefully the stuff rots over the next 30 years. Cheap insurance policy though. Ordering more when I figure out where to keep it.


Wed, 05/12/2010 - 16:50 | 347434 Robert J Moran
Robert J Moran's picture

A systemic change in which the precarious financial balance is toppled would simply wipe it off the face of Fashion Island overnight.

LOL... touche!

Wed, 05/12/2010 - 16:56 | 347448 Robert J Moran
Robert J Moran's picture

 it always goes on too long because the minister always enjoys giving it more than the audience enjoys receiving it.

Thank you very much. 

Paul McCulley

   Put THAT on a t-shirt!

Wed, 05/12/2010 - 17:11 | 347494 MarketTruth
MarketTruth's picture

REMEMBER: The US dollar is backed by nothing other than faith. Not only does it have no intrinsic value, it does not even have the blessing of fairy dreams and stardust.

Once faith is lost, so is the scam called the Federal Reserve and their commercial product printed out of 'thin air' called the United States Dollar.


Wed, 05/12/2010 - 19:21 | 347822 asteroids
asteroids's picture

The current banking system is immoral. They do nothing for the public good anymore. They should be considered evil and put out of our misery.

Wed, 05/12/2010 - 17:15 | 347505 Gilgamesh
Gilgamesh's picture

In fact, it was later that month that I actually coined the term “Shadow Banking System” at the Fed’s annual symposium in Jackson Hole.



Paul, you coined nothing.  Shadow Banking was used long before your little trip to the Devil's Playground...

Wed, 05/12/2010 - 21:29 | 348118 Booger Smoot
Booger Smoot's picture

No kidding.  That term has been around longer than McCully's first ass fingering from Bill Gross.  This is his Al Gore created the internet moment.

Wed, 05/12/2010 - 17:31 | 347543 Implicit simplicit
Implicit simplicit's picture

Real estate leveraged instruments were and still are what is going to bring this economy to its knees. The foreclosures are coming big time, both in residential and commercial. When it starts happening we will have a crash. It is just a matter of time. Falling wages and high unemployment will not allow the fed to reach the Keynsian inflection point of a self-sustaing recovery, 

Wed, 05/12/2010 - 17:32 | 347547 10044
10044's picture

He's the fk-head who along with the sht-head krugman said 'we need a housing bubble' in 02. Don't believe me? Google "dubya's double dip" and u'll find out.
Good news is that They're all gettin fcked by gold right now

Wed, 05/12/2010 - 18:07 | 347629 jory
jory's picture

Paul is the biggest Steaming Pile of Dung I've ever seen.  

Wed, 05/12/2010 - 18:11 | 347640 simon says
simon says's picture

So I missed something ... (1) Shadow banking created to mimic banking and get part of monopoly NIM profits (2)  Shadow banking went overboard and forward integrated into mortgage origination, bought out rating agencies and created fraudulent securities ... replacing NIM with origination and structuring fees (3) Commercial banks bought the crap that shadow banks created and suffered capital hits (4) Fed and US Treasury recapitalized commercial banks (and shadow banks who wore commercial bank drag to get TARP ... shameless bas#ards), bot toxic securiries at par and generally licked the shadow banks' b#lls  (5) Toxic sludge now sitting on Commercial Banks', Fed's, Fannie's, Freddie's and US Treasury's off-balance sheet Cayman accounts (oops, did I say that?) getting radioactive and smelling really nasty and going nowhere and preventing lending to good businesses and killing the US economy ... and McCulley's solution is:   REDUCE LEVERAGE FOR THE SHADOW BANKS???  THAT'S THE FUC#ING CONSEQUENCE THEY GET???

Wed, 05/12/2010 - 21:33 | 348134 trav7777
trav7777's picture

You forgot (6), the regulatory regime pursued by Congress and the ex-CEO of Goldman Squid, Bob Rubin, made it so that the toxic securities arms of the banks could merge with your deposits.  They got to use ordinary joes' funds to lever the shit out of everything.

The banking collapse would not have spread to retail banks nor would ever have gotten as large as it was had this firewall between IBs and retail banking been broken down for the "greater good" of Wall Street.

The solution espoused above is to revalue worthless shit to par via monetization.  Bcoz the banks and agencies that owned it or got in congested in their conduits were on the capital hook had it been valued fairly and there would have gone ALL our deposits.

This is what really happened; banks needed to offload the zillions of this shit and the music stopped.  Every one of them had massive off-sheet vehicles intended to use leverage to aggregate crap for sale.  Then the ponzi stopped and they were all on the hook to pay somebody what they'd borrowed.  The collateral they borrowed against was all OUR money.

The appropriate measure to take would have been to have BROKEN UP the banks into retail facilities (utility like) and segregated the IBs and said fuck you to all those associated with them.  Pursue your claims against the executives.  That is what would have been fair.

Instead they put us all on the train tracks.

Wed, 05/12/2010 - 18:49 | 347730 fThis
fThis's picture

It is interesting that a moral hazard has morphed into a "public good."  Deposit insurance relieves depositors of the responsibility of due diligence when choosing which bank to do business with, while at the same time relieving banks of the duty to properly manage risk to avoid losing depositors' funds... or maybe I'm just naive...

Thu, 05/13/2010 - 00:11 | 348398 Gromit
Gromit's picture

public good is simply the opposite of a private good. No value judgement was intended in this context.

Wed, 05/12/2010 - 19:38 | 347885 Yossarian
Yossarian's picture

I'm not fan of central banking but even Bagehot said: lend freely but against good collateral and at punitive rates in the event of a credit crisis.  But this was likely more of a solvency crisis and, besides, The Fed lent freely against crap collateral and at generous rates.  The system and all the participants who are biased towards it are a disgrace.  

Wed, 05/12/2010 - 21:14 | 348097 trav7777
trav7777's picture

McCulley is a moron:  what happened was not good.

The Fed made instruments that were literally WORTHLESS by design and made them into par instruments.

The error was in ever allowing dogshit to be sold as AAA paper.  The bankers found a way to run a ponzi scheme; pure and simple.  And the Fed just monetized all the worthless claims.

The shadow banking system DESERVED a run.  Any time a banking system is shown to be KITING or lending what they do not have or let's say you catch the banker out BLOWING the deposits on hookers & coke, you HAVE to run the bank!

The bankers and all the firms responsible should have been imprisoned, broken up, hanged...and yes that includes Bob Jewbin and all the rest of these incestuous crooks.  All the way to the top of the Treasury and Federal Reserve...hanged.

This PIMPCO idiot doesn't seem to understand what the cause was...when the future is contractionary, ALL debts become increasingly infeasible as a "going concern."  It becomes clear at the point of debt saturation that these claims cannot be paid and so there is a rush to redeem first.

Thu, 05/13/2010 - 00:16 | 348402 Gromit
Gromit's picture

McCulley is brilliant and he writes superbly.

Everyone here who wants to abolish the Federal Reserve should be careful what they ask for. Studying this text will give the obvious reason why.

It is not the Federal Reserve which is the problem, it is its current officers who have chosen to serve a narrow based elite.

Thu, 05/13/2010 - 01:39 | 348482 Apostate
Apostate's picture

Actually this has been well known within the executive levels of the major investment banks for a long time.

The banks are obligated via fiduciary duty to prop up the governments that they operate in. It's just a matter of attempting to control whatever moron is in power to keep them from running everything off of the rails and to prevent the savages from beating each other up.

The trouble is that the intellectual culture within the US and elsewhere is fundamentally retarded. The media is garbage. They never grew out of the WWI period and afterwards.

Speaking of which, I had a great deal of fun playing Deep Throat to a New York Times consultant a couple months ago. I'm unsure of how it ultimately played out, but I started a Goldman Sachs LBO rumor.


Thu, 05/13/2010 - 04:09 | 348552 pak
pak's picture

The speach is so fluent but I get a sick feeling when I read it.

McCulley's logic: not making money through cconventional banking? Create smth which walks like a banking system, talks like a banking system, looks like a banking system - but surprisingly, is not a banking system for regulatory purposes.

Make money, then mess the whole thing up - and get bailed out just as if your creature was a true banking system so that you make even more money, and mess it up again, on a truly magnificent scale.

Talk moral hazard!

I do understand that if we allow the "shadow" (read "fake") banking system collapse now, we'll be in real trouble, but there's no way I can accept this guy's definition of "good". We cannot move forward till we accept that this pseudo-banking-system serves no "public good" (I hope McCulley doesn't claim he coined that term, too) but is in practice just a rent-seeking parasite.

Yes, Mr. Volcker, you're right on "rent-seeking", but where were you 10, 20, 30 years ago?

And what I really don't get is why we need a "big government" to clean up the mess which could've been prevented by a much smaller government. Mr. McCulley, you're so greenspanish!

All in all, this is the financial nomenklatura of "shadow socialism" singing anthems to itself!

Thu, 05/13/2010 - 22:23 | 350819 fThis
fThis's picture


Thu, 05/13/2010 - 04:16 | 348556 Grand Supercycle
Thu, 05/13/2010 - 04:19 | 348558 Grand Supercycle
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