The new “carry trade”?

Loosely regulated non-bank lenders have emerged as among the biggest beneficiaries of the Federal Reserve’s ultra-low interest rates with three specialist categories increasing their assets by almost 60 per cent since the height of the financial crisis.

Such lenders, widely considered part of the “shadow banking” system, have expanded rapidly on the back of investors who are clamouring for the higher returns on offer from financing riskier types of lending.

From the FT, there is more here.


The irony of the past five years is that while central banks have been trying to flood the markets with cheap capital, banking regulators have been significantly tightening the regulatory cost of capital for almost all activities. The two are operating at complete cross-purposes.

Interest rates may be zero, but capital charges have become so high that banks can't do any lending regardless.

The effect of this might be that monetary policy will be less transparent, more fitful, more pro-cyclical, and more subconscious.

I have been preparing for the approaching maturation of the business cycle by considering the Fed's management of their balance sheet, Fed Funds rate, and interest on reserves (IOR). But, this adds an extra wrinkle to the issue. Cash is not a constraint, by a long-shot. What if a sort of unnoticed, pro-cyclical bias creeps into the subtle tactical decisions of bank regulators. From a monetary policy point of view, operating in a sort of continuous function of interest rate policy, we might hope that the Fed would raise the Fed Funds rate and pull IOR up along with it in order to induce banks to hold onto reserves until the Fed can unwind its Treasury holdings.

But, what if banks have potential credit opportunities now that represent fair value several percentage points above the market rate, but they are currently being held back by capital scarcity and regulatory constraints. If these constraints are lifted, credit creation could ramp up faster than the Fed can manage it.

I would expect forward interest rates stemming from FOMC policy to be pretty stable, and probably low, but I wonder if this sort of regulatory risk is where an inflation shock scenario could come from.

Sorry. That was a reply to Doug.

If the Fed keeps it's eye on returning ngdp to its pre crisis trend, I don't see how this is a problem of monetary policy.

That's an excellent point, one that I've never really heard anyone express anywhere else. In fact the pro-cyclicality of bank capital charges might not even require a relaxation of policy. Most regulatory capital risk is derived using some 5-10 year historical window. As the crisis of 2008-2011 rolls out of that window (replaced by our current very low volatility market), implied risk will naturally go down. This should lead to banks levering up again, while still staying within the same regulatory risk limits.

I just look nervously at the REITs. Seriously, something will eventually have to give since they pay dividends in 10-20% range.

Can we make sure that only institutions not still "too big to fail" lend to these entities?

Tee hee! Is the Fed purposely circumventing the increased regulation from Dodd Frank, or is it unexpected, some well educated fools getting rolled? Either way it is quite amusing.

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