Just read this post, and of course the entire site is superb. The post is hard to summarize, but here are a few bits:
FT Alphaville has spent much of the past year thinking about collateral shortages in the shadow banking system and how safe assets function as a kind of currency.
But it’s about time someone actually calculated just how much money these assets might represent.
And, now quoting Credit Suisse:
Less debt, lower value, higher haircuts, and reduced collateral velocity: in our view, this is an ongoing and significant monetary shock.
Back to Garcia:
…that precipitous fall in private shadow money amounted to tremendous deflationary pressures.
Don’t forget this:
And yes, that does lead to an argument against tightening fiscal policy too quickly: fiscal consolidation tightens monetary policy also.
Here are three more knockout paragraphs:
It’s no longer enough to understand traditional monetary policy transition mechanisms (money multipliers, federal funds rates, reserves); it is also necessary to understand the shadow banking system (collateral supply, rehypethecation) affect monetary policy, and vice versa.
And this also seems like the source of the many challenges in working out how to regulate the sector.
Because one thing that’s clear from the note is that the shadow banking system represents a lot of money, and more specifically a lot of credit flowing through the economy. Regulating it won’t be as easy as saying bring it all on balance sheet or higher capital standards (though the latter is probably still a good thing).
In the post there is much much more, and do check out the graphs and the discussion of Gary Gorton. We are just beginning to understand this critical angle of the financial crisis.
Garcia also recommends this excellent link, very good on collateral and shadow banking.