Shadow Banking: Is the Serpent Back in the Garden?

Not five minutes ago I received an email titled: “Personal Loans Trusted Lenders Ready to Lend up to $35,000…”

This was the fifth or sixth email of this nature I have received just this morning.  Of course, most of these are spam, filled with malware or links to nefarious sites that will do great damage to my computing devices.  I hope it goes without saying you should always check the validity of any email address and do not click on anything even remotely suspicious.

Yet some of these, it turns out, are quite legitimate from basically legitimate lenders.  No, not banks.  But lenders of a different sort in an industry that has come to be known as “Shadow Banking.”

Recently, Lisa Brammer and I have been writing a lot about financial literacy and doing the right things to manage our finances and debt.  I think this one should go under the general heading of ‘buyer beware’ or ‘if it seems too good to be true it probably is’. 

Shadow Banking is not really new, and previously has had pronounced, and downright insidious effects on the economy.  Those of you who recall our last economic recession know that it was principally caused by the subprime mortgage crisis in 2007-2008.  In fact, our recession led to a worldwide recession from which we have only recently recovered.  Shadow Banking was a source of many of these so-called subprime loans.  Perhaps you thought that was the last we would have heard of this ‘serpent’ in the financial garden.  Think again. 

Shadow Banking has once again grown to be a huge source of competitive lending offering low rates and quick cash for everything from home mortgages to auto loans.

According to Wikipedia “The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations. (emphasis added)”

That last is an important caveat.

Wikipedia goes on to add “The phrase ‘shadow banking’ contains the pejorative connotation of back alley loan sharks. Many in the financial services industry find this phrase offensive and prefer the euphemism ‘market-based finance’.”

No less an authority than former US Federal Reserve Chair Ben Bernanke defined Shadow Banking further in November 2013:  “Shadow banking, as usually defined, comprises a diverse set of institutions and markets that, collectively, carry out traditional banking functions — but do so outside, or in ways only loosely linked to, the traditional system of regulated depository institutions. Examples of important components of the shadow banking system include securitization vehicles, asset-backed commercial paper [ABCP] conduits, money market funds, markets for repurchase agreements, investment banks, and mortgage companies.”

The long and short of it is while they may look like banks, act like banks, lend money like banks they are not banks.  While they have become subject to some level of regulation, they certainly don’t provide safeguards for your money as do traditional banks and the Federal Deposit Insurance Corporation (FDIC).

Yet the industry has once again become huge.  Like $52 trillion huge.

In an article posted on CNBC.com (“Shadow banking is now a $52 trillion industry, posing a big risk to the financial system” read the article here), reporter Jeff Cox says this is a 75% increase since the last financial crisis of 2007/2008. 

“Nonbank lending, an industry that played a central role in the financial crisis, has been expanding rapidly and is still posing risks should credit conditions deteriorate” writes Cox. “…these institutions helped fuel the crisis by providing lending to underqualified borrowers and by financing some of the exotic investment instruments that collapsed when subprime mortgages fell apart.”

Cox continues: “The U.S. still makes up the biggest part of the sector with 29% or $15 trillion in assets, though its share of the global pie has fallen. China has seen particularly strong growth, with its $8 trillion in assets good for 16% of the total share.”

Quoting no less an authority than J.P. Morgan Chase CEO Jamie Dimon (from his annual letter to investors) “The growth in non-bank mortgage lending, student lending, leveraged lending and some consumer lending is accelerating and needs to be assiduously monitored,”

Additionally DBRS, a bond rating agency, said: “The exposure of the global financial system to risk from shadow banking is growing…Weaknesses in these shadow banks arising from these activities could result in runs that could instigate or exacerbate financial market stress.”

To be fair, the industry says that they provide an important function to the economy by providing access to loans and other financial instruments that can help those who cannot qualify for traditional loans.  Perhaps so. 

Yet, according to Cox, “DBRS identified three specific risks that shadow banks pose under times of market stress: That they are ‘not structured’ to deal with periods of low liquidity and heavy withdrawals; a lack of experience in dealing with periods of weakening credit conditions, and a lack of earnings diversification that would hurt them when parts of the markets deteriorate.”

So, some word salad there, but the bottom line is that consumer debt has grown to historic proportions once again and any volatility in the economy could create a tipping point we can’t recover from very easily.  Shadow Banks are not equipped to handle sudden reversals in revenue inflows.  Perhaps making this even worse is the fact that this just does not apply to mortgages, the industry has expanded to student loans, auto loans and other consumer credit instruments so the impact could be even more widespread should conditions suddenly change. 

So, is the serpent back in the garden?  Perhaps; perhaps not. Yet the hissing is unmistakable.

A. Alliance Collection Agency, Inc. is a full service, licensed accounts receivable management and debt collection agency providing highly effective, customized one on one management and recovery solutions for our business partners.  Founded in northern Illinois in 2005, we have been proudly improving the bottom-line on behalf of our business partners in and around Chicagoland for over 14 years.

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What’s Causing Record Household Debt in America? Financial Illiteracy?

Collectively, we as Americans owe a record amount of money—over 13.5 trillion dollars. Yikes!  If you’ve read any of our recent blogs you already know this. But what you might not know is that the recent report by The New York Fed (Mark talked about in last week’s blog) says that while the amount of debt is higher than before the great recession it’s not as risky this time around because things are different. Phew!

Debt in of itself isn’t a bad thing. It can be good when it allows us to buy a house, a car or a college degree we could not otherwise afford.  But it’s important to keep a good handle on our finances to not only understand what’s coming in versus what’s going out and the ability maintain a good balance of both. We also need to be able to understand basic financial concepts like risk diversification, inflation, interest and compounding interest.

Right now our economy is booming with unemployment at a fifty-year low and wages rising. You’d think we’d be having a field day getting our finances in order wouldn’t you? But according to a recent survey by Bankrate that’s not the case at all. We are actually marching in the opposite direction. (That’s why Mark and I keep writing about this topic!)

For example, this year’s report found only 44 percent of households surveyed have more money in emergency savings than the amount they owe in credit card debt. I can shine a brighter light on that 44 percent by telling you it is 14 points lower than last year’s 58 percent and the lowest percentage in Bankrate’s nine year history of conducting this survey. To make matters worse these numbers probably won’t be getting better soon because according to the same report only 43 percent of those surveyed said they were focusing on boosting their emergency savings this year, down from 53 percent last year. Uh Oh!

A couple of months ago I read an article in investmentnews.com called, “Financial Literacy: An Epic Fail in America.” The title pretty much says it all.  The article talks about a 23-year-old graduating senior at a Texas university who was starting his first post-graduation position when he had the rude realization that he had to begin paying back his $90,000 worth of loans and what that really meant in monthly payments—about half of his new monthly salary. This student made it through all those years of schooling plus four additional years of higher learning yet he had no idea what he had gotten himself into.

Sadly this is not an isolated event and many Americans (as well as many people world-wide) struggle with financial literacy. It begs the question: Are students learning enough about how to manage their money?

The Center for Financial Literacy at Champlain College doesn’t think so.  Established in 2010 the center was designed to promote and develop financial literacy skills in k-12 pupils as well as college students, teachers and other adults. In 2017 the center graded each of the states on a National Report Card on Financial Literacy. Sadly only five states received an “A”. 

Wisconsin, where I live, scored an “F” on that report.  That’s probably what prompted then-Governor Scott Walker to sign a bill requiring school districts to incorporate personal finance into k-12 instruction.

With these types of statistics trending like they are, it’s easy to see how many Americans—even in a good economy—are struggling to keep up with their debt. We need to educate ourselves and our youth on financial literacy now! If not, I don’t want to even think about what’s going to happen when our economy takes a tumble.

A. Alliance Collection Agency, Inc. is a full service, licensed accounts receivable management and debt collection agency providing highly effective, customized one on one management and recovery solutions for our business partners.  Founded in northern Illinois in 2005, we have been proudly improving the bottom-line on behalf of our business partners in and around Chicagoland for over 14 years.

Another Record for Household Debt: No Comic Relief Here!

Over the last few weeks my friend and colleague Lisa Brammer and I have been writing about the need to improve our financial literacy. Taken as a whole we consumers are ‘woefully inadequate’ in terms of our understanding of basic financial instruments and ways to manage our personal finances, let alone how our economy works and what drives it. 

Much of our writing has been in relation to Financial Literacy Month, which concluded this past April.  Many financial institutions, as well as Federal and State Governments, used this month to promote greater understanding of critical financial concepts and provide basic tools that are available to the public to help put their financial lives in order.

That is no small task, however, and given the state of household debt it is like turning an aircraft carrier on a dime: it just does not happen quickly.

Yet, as the old saying goes, a long journey starts with a single step.  And sometimes that single step is the hardest to take.  But take it we must or at some point face some pretty dire consequences.

More in a moment on another unique educational tool the Federal Reserve of New York makes available to the public.

But first, to underscore the need for personal financial house cleaning, the New York Fed just released its report on first quarter household debt. 

No surprise: we set yet another record for debt accumulation.  Among the findings from the Fed (read the report here).

  • Total household debt now stands at an unbelievable $13.67 trillion.  All one can say is wow!
  • Debt increased by $124 billion during the quarter.
  • This is the 19th consecutive quarter that household debt has increased.
  • Total household debt increased during this stretch by nearly $1 trillion ($993 billion).
  • Mortgage balances rose by $120 billion while originations declined to the lowest level since the 3rd quarter of 2014.
  • Student loan debt increased by another $29 billion to $1.49 trillion.
  • New auto loans grew to $139 billion.
  • Credit card balances fell slightly to $848 billion.
  • Notes the New York Fed: “As of March 31, 4.6% of outstanding debt was in some stage of delinquency. Of the $623 billion of debt that is delinquent, $417 billion is seriously delinquent (at least 90 days late or “severely derogatory”).”

Clearly, we have our work cut out for us and greater focus needs to be put on financial education before this trend ends in disaster.

In an earlier blog I referenced a site run by the U.S. Government called “MyMoney.Gov” (www.mymoney.gov). Its focus is on basic financial literacy and education, and also provides basic financial management tools to help consumers put their affairs in order. 

To my surprise, however, another tool has been made available by the New York Federal Reserve to educate young people in the hopes that earlier understanding will lead to mature financial decisions in adulthood.

The tool? 

Comic books.

Yes, comic books.  And before you laugh and wonder about another crazy government project there is method to this madness, and comic books have been used by the Federal Reserve for years (since the 1950’s) as aids for teachers and other educators to enhance learning.

According to the New York Fed’s web site: “The New York Fed’s Educational Comic Book Series teaches students about basic economic principles and the Federal Reserve’s role in the financial system.  Created for students at the middle school, high school, and introductory college levels, the series can help stimulate their curiosity and raise their awareness of careers in economics and finance.”

No Batman and Robin here however.  Here we encounter (on the planet “Novus”) “Mr. Murt,” “Flora” and “Q-seven, a blue cube from the planet Alpha-Numerica” among other characters.  Admittedly the comics don’t exactly have dynamic, action packed titles. Here you will find “The Story of Monetary Policy” and “The Story of the Federal Reserve System.”

Yet the intention is very good and the content easy to understand which makes understanding the fundamentals of how our overall economy works a little less wonky and a lot more every day.  If you are an educator, or even someone just trying to understand what the Fed does, or what monetary policy is, check them out at https://www.newyorkfed.org/outreach-and-education/comic-books .

The fact is it will take an abundance of tools and an early start to drastically improve our financial literacy.  However, it is crucial that this start now.  Even if taken in small steps these efforts will help educate consumers on managing their burgeoning debt before the effects become catastrophic.

A. Alliance is here to help.  We supply a key component in the economic chain to ensure our client’s recover their debts and keep their businesses operating smoothly in good times and in bad.

A. Alliance Collection Agency, Inc. is a full service, licensed accounts receivable management and debt collection agency providing highly effective, customized one on one management and recovery solutions for our business partners.  Founded in northern Illinois in 2005, we have been proudly improving the bottom-line on behalf of our business partners in and around Chicagoland for over 14 years.

image provided by: Alpha Stock Images – http://alphastockimages.com/