The following chart was prepared by PhD scientists at the New York Federal Reserve Bank for a research paper concerning the "Shadow Banking" system. This is an abstract from their report:
Shadow banks are financial intermediaries that conduct maturity, credit, and liquidity transformation without access to central bank liquidity or public sector credit guarantees. Examples of shadow banks include finance companies, asset-backed commercial paper (ABCP) conduits, limited-purpose finance companies, structured investment vehicles, credit hedge funds, money market mutual funds, securities lenders, and government-sponsored enterprises. Shadow banks are interconnected along a vertically integrated, long intermediation chain, which intermediates credit through a wide range of securitization and secured funding techniques such as ABCP, asset-backed securities, collateralized debt obligations, and repo.
This intermediation chain binds shadow banks into a network, which is the shadow banking system. The shadow banking system rivals the traditional banking system in the intermediation of credit to households and businesses. Over the past decade, the shadow banking system provided sources of inexpensive funding for credit by converting opaque, risky, long-term assets into money-like and seemingly riskless short-term liabilities. Maturity and credit transformation in the shadow banking system thus contributed significantly to asset bubbles in residential and commercial real estate markets prior to the financial crisis.
[You may have to download the chart to get the necessary viewing resolution.]
Last week Gillian Tett, wrote a short piece about this chart in the Financial Times. Gillian is one smart woman and she has written an authoritative book on derivatives and securitizations called: "Fools Gold".
Here is what she had to say about this chart: "These flows are so extraordinarily complex that hundreds of boxes create a diagram comparable to the circuit board of a high-tech gadget. Even as poster size, it is difficult to decode." [Source: Road Map That Opens Up Shadow Banking]
If Gillian Tett is saying this is "difficult to decode" who am I to argue.
Here is what I have to say about it. Once upon a time, taking out a mortgage to buy a home was simple, you took out a loan and paid origination points to your bank. But then it became very complicated...
Somehow we wound up with an "Intermediation Chain" that looks like this...
Why did this happen. Wall Street says that previously inaccessible capital was unlocked for the noble purpose of providing homes for millions of Americans.
Bullshit! What really happened is the distance between the source of capital and the end user was stretched to the Squid Event Horizon. Remember how many times we heard that term "Intermediary" used by Blankfein during the Abacus hearings? The game is to stretch and complicate and derivate the capital pipeline beyond comprehensibility and charge an endless series of toll fees and commissions at every step of the way. The key is stretch, complicate and derivate!
The end result, a humongous misallocation of capital and physical resources, humongous fees and bonuses and a humongous shadow banking chart.
I will attempt to simplify it all thus...
One chart for Gillian:
And one chart for the rest of us...that's Ummmmmmmm not Om!