Acharya, Viral, and Philipp Schabl, 2009, “Do Global Banks Spread Global Imbalances?” 10th Jacques Polak Annual Research Conference, November 5–6, 2009.
Carney, Mark, 2011, “Some Current Issues in Financial Reform” Remarks presented to the Institute for International Finance, 25 September, 2011, Washington, D.C.
Greenlaw, David, Jan Hatzius, Anil Kashyap, and Hyun Song Shin, 2008, “Leveraged Losses: Lessons from the Mortgage Market Meltdown,” U.S. Monetary Policy Forum Conference Draft, February 29, 2008.
Greenwood, Robin, Samuel Hanson, and Jeremy Stein, 2010, “A Comparative Advantage Approach to Government Debt Maturity” Harvard Business School, Working Paper No. 11-035.
Krishnamurthy, Arvind, and Annette Vissing-Jorgensen, 2010, “The Aggregate Demand for Treasury Debt,” NBER Working Paper No. 12881.
Pozsar, Zoltan, 2010, Adrian, Tobias, Adam, Ashcraft, Boesky, Hayley, “Shadow Banking,” Federal Reserve Bank of New York Staff Report No. 458, July.
Singh, Manmohan, and James Aitken, 2010, “The (sizable) Role of Rehypothecation in the Shadow Banking System,” IMF WP 10/172, Washington, D.C.
We wish to thank helpful discussions with Hyun Song Shin, James Aitken, Olivier Blanchard, Stijn Claessens, Karl Habermeier, David Marston, Perry Mehrling, Aditya Narain, Phil Prince, Alex Roever, André Santos, Darrel Duffie, Eric Stein, Vijay Sunderajan, Peter Stella, Sunil Sharma, and James Sweeney.
By dealers we mean the 10-15 banks active in collateral management and not traditional commercial banks.
U.S. banks typically rehypothecate “collateral received that can be pledged” with European banks and vice versa. The U.S. and European markets are roughly equal in size; hence we add about 50% of the $10 trillion pledged collateral figure for the U.S. The traditional U.S. banking system was estimated at $13 trillion prior to Lehman’s demise; thus the shadow banking system was sizably larger than the traditional banking system.
Importantly, this implies that in many instances what seems to be institutional cash is ultimately retail cash.
In practice, the demarcation between levered and real money accounts is not clear, as many real money accounts today incur leverage, deal in derivatives and have the ability to go short. Thus, dealers may mine collateral from real money accounts through the same way they use to mine collateral from levered accounts.
The means through which collateral is mined may be “active” or “passive” in that it is either a dealer or an account that initiates the transaction. From dealers’ perspectives, collateral mining can be considered active if dealers call up hedge funds or real money accounts looking for collateral, and passive if the accounts that call up dealers to for example raise cash or borrow (or short) certain securities in exchange for posting collateral.
The typical description in financial statements of collateral than can be re-pledged is: “As of December 2009 and November 2008, the fair value of financial instruments received as collateral by the firm that it was permitted to deliver or re-pledge was $561 billion and $578 billion, respectively, of which the firm delivered or re-pledged $392 billion and $445 billion, respectively.” Source: Goldman Sachs 2010 Annual Report.
This notation does not fully accord with current accounting and regulatory conventions. For example, from a regulatory point of view, until Basel III is implemented, leverage refers mostly to on balance sheet leverage. According the definition of Basel III, several off-balance sheet items will come on the balance sheets by 2017. These include commitments (including liquidity facilities), unconditionally cancellable commitments, direct credit substitutes, acceptances, standby letters of credit, trade letters of credit, failed transactions and unsettled securities (in the Basel III “handbook” see pp. 82–83 (§ 83(i)); pp. 84 (§ 84(i)–(iii)); pp. 85–86; and pp. 88–89).
Household deposits grow in line with household wealth and income, i.e., steadily.
Shin and Adrian (2010) note that “M2 […] is a good proxy for the total stock of liquid claims held by ultimate creditors against the financial intermediary sector as a whole” and later demonstrate that M2 has been slow moving or stable over time, expanding “by a factor of 2.4 since 1994”. Shin (2009) notes that “the total liabilities of the banking sector to the household creditors can be expected to be sticky, and would be related to total household assets. […] For the purposes of short-term comparative statics, we could treat it as a constant.”
Leverage is typically measured on a gross basis and interbank lending on a net basis. As an example, if bank A wants to buy a million dollars of securities from a person and gets financing from Bank B (on the basis of the collateral of the securities) which refinances from Bank C, which in turn refinances with Bank D which receives the cash as a deposit from a nonbank source (i.e., household or mutual fund). We have assets of Banks A, B, C and D go up by $1 million each, for a total of 4 million; gross interbank lending/borrowing of $3 million and financing from nonbanks of 1 million. Since capital has not changed, leverage goes up (assets of the banks go up by 4) and the proportion of financing from nonbanks goes down. Assume “z” is the proportion of nonbank funding to the banks; thus the total bank financing goes up by 4 million of which only 25% is from nonbanks.
Aside from U.S. Treasury Bills that is often cited, we do not exclude Bunds or other AAA government securities; or gold; or currency (e.g., recently, the Swiss Franc).
Nonbank financing is not “sticky” and the proportion of nonbank financing does not have to shrink to compensate for an increase in leverage.
Since the money holdings of asset managers are ultimately the claims of households, it follows that households ultimately fund banks through both M2 and non-M2 instruments. It is important to note, however, that while households’ direct holdings of M2 instruments reflect their own investment decisions, their indirect holdings of non-M2 instruments are not a reflection of their direct investment choices, but the portfolio choice and investment management techniques of their fiduciary asset managers.