A “shadow banking system” is being constructed in Ireland. It has enormous potential to torpedo the future growth path and risks another banking crisis in time.
The term shadow banking system was coined by my former boss, the economist Paul McCulley, to describe the activities of all sorts of funds that are in his words “a whole alphabet soup of levered-up investment conduits, vehicles and structures”. The term perfectly captures the nature of a business, which significantly contributed to the global economic crisis.
A shadow banking system is a parallel banking system. It behaves like a banking system but it’s not. It is all sorts of investment funds which lend money. But the institutions aren’t places you go into with your deposit and open an account. A shadow banking system manages to get finance in other ways and then lend this money into the economy
The Irish Central Bank has just announced that it will allow hedge funds – the most greedy, unscrupulous, short-termist financial subspecies out there – to lend money to Irish corporations. This truly beggars belief.
Hedge funds are the most highly speculative, profit-driven financial companies in a vast avaricious eco-system that is the financial markets. The aim of the hedge fund is to maximize profits in the very short-term. This involves taking big bets on certain assets – usually stocks or bonds – and if you make money, great – but if the asset is not performing you sell as quickly as possible. Involving these people in the business of lending to ordinary companies will completely destabilize the economy and lead to much more amplified boom/bust credit cycles than we have even seen in the past fifteen years.
The incentive structure built into hedge funds means the hedge fund manager has to take big bets.
As financial markets continue to rise, most hedge fund managers are worried about investing in expensive markets now. Therefore, they are looking for new pastures to make money and lots of it.
When the only objective of the lenders is to make lots of money, you can be sure that this is not good news for the borrower!
To make this money, the hedge fund raises money from rich investors or institutions and takes a fixed management fee of maybe 2pc of the total capital committed. After that, the hedge fund manager gets 20pc of any profits the fund makes over a certain minimum amount.
Because the hedge fund managers share the profits but not the losses, they are always incentivized to take big bets and are less concerned about losing money than making it. In addition, what distinguishes hedge funds from mutual funds is that they can borrow as much as they like in their pursuit of profit.
Are these the types of people that should be lending into the Irish economy? Is this the type of financing which is designed to create a sustainable growth path in the future?
They are moneylenders of the old-fashioned type. Yet according to the reports yesterday, hedge funds based in Ireland will be able to lend to companies under new rules drawn up by the Central Bank.
Apparently, the Central Bank has issued a consultation paper on its proposed rules and expects them to be in place by the end of the year.
Because banks are still reducing their lending to households and corporations six years after the financial crisis, the Central Bank claims that there has been increased demand for new sources of lending from firms in Ireland and abroad.
Under the new rules, a loan fund will not be able to lend more than a quarter of its assets to one borrower and the amount of debt the fund can take on will be capped at a ratio of one to one, meaning that if a fund has assets of €100m it can borrow another €100m.
But the issue is not how much money they lend; it is how they lend it and why.
The banking crisis in Ireland was caused by a combination of too many big loans and far too many little loans. The reason the banks lent too much money is that they were driven by short-term profiteering and the short-term movement of their share prices. They paid themselves in the shares of their banks, so self-interest drove them to push up the share price.
Such activity gives credence to the observation that the easiest way to rob a bank was to run one.
Traditionally banks were robbed by criminals breaking in, but in recent years banks were robbed by executives on the inside breaking out.
The managers of hedge funds will have an even bigger incentive to take risks because the link between their own pay and the profits of the fund are even more direct. If the central bank is prepared to allow hedge funds lend in Ireland how big might this move be?
In 2009, it was reported that there are over 350 financial companies operating in the Republic, despite the fact that many have little or no employees and are experts in tax avoidance. The ‘shadow banking’ system’s assets comes in at a whopping €1.7 trillion.
The proposed new regulations over the shadow banking sector specifies that there will be a cap on the amount of debt a fund can hold, with a ratio of 1-1. Thus, considering that the total value of the Irish shadow banking system’s assets to be €1.7trillion, it can borrow a further €1.7trillion.
This is a huge amount of money in the hands of people who are incentivized to take risks with it in the real economy. Is this a sensible route? Imagine if a fraction of that gets into the south Dublin housing market?
I suggest we hold onto our seats!
Subscribe.
Mr Tepper heading back to our shores?????
http://youtu.be/myvyGl6yo64
This will not end well !
http://goo.gl/z1k9MH
Insanity: doing the same thing over and over again and expecting different results.
Albert Einstein
“Because the hedge fund managers share the profits but not the losses they are more incentivised to take big bets and are more concerned about making money and less about losing it.” Sounds like standard fractional reserve banking to me. At least these guys won’t come looking to be bailed out by the tax payers to the tune of 60 billion if they make a balls of it. Also there is no chance of depositors losing most of their deposits in a “bail in” scenario which is now just a matter of time with the main banks. The hedge fund… Read more »
I really don’t see how this is such a bad idea. The free market kicking in with €1.7T to lend out; at least no one would expect the government to bail them out. And if no one is going to bail them out, I’d expect they’d be somewhat more careful with their lending criteria.
If the main street banks won’t lend, then it seems this is at least an option.
Hi, “Are these the types of people that should be lending into the Irish economy? Is this the type of financing which is designed to create a sustainable growth path in the future?” No. They are not paid to take risks David they are paid to DESTROY the place let me explain; Take property developers. McFeely was the ex con ex IRA man who was working as a labourer after he got out of jail and was developing hundreds of apartments in the priory hall development. Behind the scenes someone in a bank somewhere lent him the money to do… Read more »
“In 2009, it was reported that there are over 350 financial companies operating in the Republic, despite the fact that many have little or no employees and are experts in tax avoidance.”
Thanks for writing that David.
Richard Bruton has the gall to deny Obama’s accusation that the Irish are “gaming the system”. Obama is right, Ireland is the Las Vegas of the financial world, the “gaming” capital of the world.
The banking crisis in Ireland was caused by a combination of too many big loans and far too many little loans.
Who/what decides how much overall lending/money creation is done by the Banks?
The interests of the financial markets or shadow banking system and the real economy are diametrically opposed.
Companies and people functioning in the real economy benefit from and want stability; financial markets benefit from and want instability.
The IFSC is a Trojan horse designed to loot our economy.
Until the financial markets are reined-in and properly regulated the crisis we have been in since 2007/8 will continue to deepen; and if unchecked will inevitably lead to a general collapse and a global disaster on a scale the human race has never before experienced.
[ The managers of hedge funds will have an even bigger incentive to take risks because the link between their own pay and the profits of the fund are even more direct. If the central bank is prepared to allow hedge funds lend in Ireland how big might this move be? ] Throw this in with low interest rates – a subsidy for speculation, and you can some rather dangerous behaviour. High risk, interest rates so low the subsidize risk, a tax system that sucks out of productive activity and rewards unproductive activity, a legal system that jails nobody unless… Read more »
Should the hedge funds, which are a large part of the IFSC’s business (which generates €2 bn in taxes) take their business to Luxembourg? As for hedge funds being incentivised to take excess risks because they are part owners of their shadow banking businesses, that is a contradiction of reality. One of the strengths of the hedge fund business structure is that the owners are usually co-investors and have a vested interest in the longevity of the business. How many hedge funds went bust since 2007? Some, not many and they imploded, not exploded. How many required bail outs by… Read more »
It was Margaret Thatcher who did away with the two and half times salary for mortgage rule in the uk. And Ireland followed. (There was a name for that regulation which I cannot recall.)
See below for a view on the long term effect of Thatchers policies.
http://www.bbc.com/news/business-22064354
All those old Bank managers who people had to tiptoe around to get a loan would have started working during the great depression and seen the effects.
Would love to see an article by David on increasing Banking Debt enslavement, and where in response BRICS de-dollarisation will lead the world.
Sounds a potential trap for SME’s to get into payday loan style lending, where unless your short term future income increases after the interest rates you’ll just end up in a worse situation very quickly
Why Argentina’s Debt Default is an Opportunity for Bitcoin
http://www.coindesk.com/argentinas-debt-default-good-bitcoin/
This one will be up Mr. bonbon’s street:
“We’re heading into a jobless future, no matter what the government does”
https://www.linkedin.com/today/post/article/20140731045824-8451-we-re-heading-into-a-jobless-future-no-matter-what-the-government-does
I’m still in shock after reading this article! These predatory financial alchemists being ‘allowed’ to feed on vulnerable Ireland will result immediately in: 1) Soaring asset prices – housing/land being further pumped 2) Rents for Joe and Jane Bloggs to RISE (by absentee landlords) 3) 1st time buyers,in Dublin region anyway,[and aside from poor supply levels of housing and wages being,at best,stagnant] won’t now have a snowballs chance after this proposed irrational move/’stroke’. This Threat of a purposeful rapid re-inflation of our property bubble is a thundering disgrace!and we were concerned about “cash buyers” ??!!.. a small fraction of E1.7… Read more »
Hi David,
It must be obvious now to you gsucks is preparing to play the same trick on Ireland as they did on Cyprus. I’d say they suspect the dollar will hyper inflate or some other event will happen but before that they will have Irish businesses in hoc and then WHAM the trap closes shut and Roisin gets it where the sun doesn’t shine: All the assets of Irish business will be confiscated in lieu of debs owed.
At least a few of us saw it coming.
Is TAFTA going to happen now or not?
DMW is gone to the dogs !!!!!!!!
http://www.independent.ie/life/irish-people-gush-about-their-canine-companions-30454729.html
Speaking of hedge funds and opportunist hunters with insatiable appetites,the pack dynamics in the wild for feral dogs,has s a very well defined hierarchy,with just one well defined Leader – The Alpha,who decides for all pack members,the where and when to sleep ,the pace of a pack hunt,where to hunt,often selects which vulnerable animal to hunt and generally assigns roles & responsibilities to all other subservient pack members,so that together,collectively,all members contribute to the furthering of the overall pack survival and while co-operation among a dog pack,features heavily in a hunt scenario,we understand now,further to extensive scientific zoologists’ studies,that democracy… Read more »
What’s the matter with me today? I suddenly find myself in agreement with Colin about what caused the famine and about not working for an Irishman; and I know bonbon’s (or J-Will?) problem: they are both insomniacs – like the schizo who said to himself “together we can beat this thing”.
Seriously Colin, you are right about both. But I still don’t like the Brits (or you) calling the Irish “Paddy”. You never hear that in America.
Blood & Tears Taxation is a primal activity with the intention ‘To STICK ‘ in the presence of ‘The Enforcer ‘( The Hunter ) . Sometimes ‘ The Enforcer ‘ is not present when the Tax Payer ( Beast of Prey ) becomes Entrapped ( Notice of Estimation ) in a Snare ( Discovery ) that is located ‘Away ‘ . The Snare is usually the location that draws the remote Taxpayer into its TERRITORY ( Taxable Activity ) . A Humane hunter allows the beast of prey to call for help when entrapped and to choose anyone ( Appeal… Read more »
Dug Out Ideas Limerick gets its name from its location where the Estuary begins .It is two Danish words for ‘Dug Out’ river which is what the Estuary is and not a Fjord .All the waters that drain from the Isles of Ireland pass through Lymricke. Shannon is the location for the first Finance Plan to legislate in the World International Tax for Companies without Borders .It was conceived by a team from Thomond and led by Brendan O’Regan .Its concept then was unique and its implementation became practiced and copied all over the world.Real Leaders in a Real Team… Read more »
An aside David,
More evidence of close to a 10% real inflation rate;
An post’s new charge for delivery of a local letter has just increased from 55c to 68c, SIXTY EIGHT CENTS DAITHI.
I shit you not.
Monbiot is at it again:
“Sick of this market-driven world? You should be”
http://www.theguardian.com/commentisfree/2014/aug/05/neoliberalism-mental-health-rich-poverty-economy