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The Side Effects of Shadow Banking on Liquidity Provision
Over the past two decades, the growth of shadow banking has transformed the way the U.S. banking system funds corporations. In this post, we describe how this growth has affected both the term loan and credit line businesses, and how the changes have resulted in a reduction in the liquidity insurance provided to firms.
Banks as Patient Fixed Income Investors
We examine the business model of traditional commercial banks in the context of their co-existence with shadow banks. While both types of intermediaries create safe "money-like" claims, they go about this in very different ways. Traditional banks create safe claims with a combination of costly equity capital and fixed income assets that allows their depositors to remain "sleepy": they do not have to pay attention to transient fluctuations in the mark-to-market value of bank assets. In contrast, shadow banks create safe claims by giving their investors an early exit option that allows them to ...
Components of U.S. financial sector growth, 1950-2013
The U.S. financial sector grew steadily as a share of the total business sector from 1959 until the recent financial crisis, when the trend reversed. In this article, the authors develop measures based on firm-level data to estimate the size of the financial sector and its subsectors relative to the total business (financial and nonfinancial) sector over time. The analysis further sheds light on how these size measures are affected by a firm?s choice of financing (whether public or private), firm size, industry type, use of leverage, and regulation. The authors find that the relative size of ...
The Growth of Murky Finance
Building upon previous posts in this series that discussed individual banks, we examine the historical growth of the entire financial sector, relative to the rest of the economy. This sector?s historically large share of the economy today (see chart below) and its role in disrupting the functioning of the real economy during the recent financial crisis have led to questions about the social value of costly financial services. While new regulations such as the Dodd-Frank Act impose restrictions on financial activities and increase their costs, especially those of large firms, our paper ...
The Final Crisis Chronicle: The Panic of 1907 and the Birth of the Fed
The panic of 1907 was among the most severe we?ve covered in our series and also the most transformative, as it led to the creation of the Federal Reserve System. Also known as the ?Knickerbocker Crisis,? the panic of 1907 shares features with the 2007-08 crisis, including ?shadow banks? in the form high-flying, less-regulated trusts operating beyond the safety net of the time, and a pivotal ?Lehman moment? when Knickerbocker Trust, the second-largest trust in the country, was allowed to fail after J.P. Morgan refused to save it.