Jurassic Banking: Shadow Banking Is Getting Bigger Without Getting Better

There is an interesting article on Bloomberg entitled “Shadow Banking Is Getting Bigger Without Getting Better” 

Taxi companies that compete with Uber and media companies that are up against Facebook know it: In a rivalry between regulated and unregulated firms, the latter have an unfair advantage. It also applies to banks, which spent the past ten years losing market share to companies that regulators ignored.

In a fresh working paper, Greg Buchak and Gregor Matvos of the University of Chicago, Tomasz Piskorski of Columbia Business School and Stanford’s Amit Seru calculated that between 2007 and 2015, so-called shadow banks have increased their share of the U.S. Federal Housing Administration mortgage market sevenfold to 75 percent. That’s the market where the less creditworthy borrowers get their loans. In the U.S. mortgage market as a whole, shadow banks held a 38 percent share in 2015, compared with 14 percent in 2007.

This is not really surprising since non-depository financial institutions have risen in force thanks in part to Washington DC’s penchant for trying to regulate anything that moves (Dodd-Frank, Consumer Financial Protection Bureau, etc.) But the growth of “shadow banks” is also linked to a growth in more risky FHA-insured loans.

And with FHA-insured loans having 4 times the serious delinquency rate than loans purchased by GSEs Fannie Mae and Freddie Mac, this is represents a dramatic shift in banking and risk taking.

As Gerald Hanweck and I showed in a recent paper, bank failures following the housing bubble and financial crisis boomed in  2009 and 2010. Most of these bank failures were small banks. This resulted in bank aggregation into progressively larger banks. These were failures of depository institutions and shadow banks (non-depository institutions like Quicken Loans) have stepped in with riskier loan profiles.

The result? The rise of the mega-banks.

As Professor Ian Malcolm said in the movie Jurassic Park, life will find a way. Including subprime lending. Welcome to Jurassic Park, where Senator Elizabeth Warren and CFPB Director Richard Cordray still believe that they can control the banking system.

 

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