A Macro View of Shadow Banking: Levered Betas and Wholesale Funding in the Context of Secular Stagnation
71 Pages Posted: 3 Feb 2015
Date Written: January 31, 2015
The literature to date on shadow banking has focused on the wholesale funding and private money creation aspects of shadow banking. This paper draws attention to those aspects of shadow banking that involve levered betas and the provision of excess returns over fixed income benchmarks. Broadening the discussion from net to gross repo, the paper highlights the role of broker-dealers as matched-book money dealers that stand between cash pools in search for safety, and various kinds of leveraged bond portfolios across the asset management complex in search for yield. This broader perspective shows deep linkages between shadow banking and asset management, including not only hedge funds but also what are assumed to be unleveraged, “long-only” mutual funds. Whereas cash pools’ problem is the structural shortage of safe, short-term, public assets (a shortage of public money), real money investors’ problem is structural asset-liability mismatches driven by the secular decline of yields on safe, long-term, public assets relative to “sticky” return targets/expectations. The secular rise of levered betas (that is, the secular increase in the use of both cash and synthetic forms of leverage in bond portfolios) has been asset managers’ way of helping real money investors bridge structural asset-liability mismatches through the provision of “equity-like returns with bond-like volatility”. To that end, the use of repo and securities lending by bond portfolios across the asset management complex exceeds the use of repo by banks and broker-dealers to fund their own bond portfolios and inventories, respectively. The “sucking sound” of asset-liability mismatches driving the secular rise of levered betas, financed through the absorption of cash pools’ money demand – “the leveraged bids glut” – is a powerful alternative to Bernanke’s “global savings glut” and Shin’s “global banking glut” hypotheses for the decline in the Treasury term premium and the compression of mortgage and other spreads before the 2008 crisis. Crowding out private money by boosting the volume overnight Federal Reserve RRPs or of U.S. Treasury bills would fix cash pools’ problems, but deepen real money investors’ asset-liability mismatches. More even-handed policies include “Dealer of Last Resort” and fixing imbalances in present incomes and future (pension) promises – a joint application of these policies would complement the G20/FSB reform agenda to date to find a better balance between the economic benefits of deep and liquid markets, and the financial stability risks inherent in the (gross) balance sheet intensity of the provision of deep and liquid markets.
Keywords: shadow banking, wholesale funding, repo, secular stagnation, imbalances, central banking
JEL Classification: E58, E44, F33,
Suggested Citation: Suggested Citation