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- The US Treasury wants to ban the term “shadow banking,” even though it is used widely in the financial industry and among regulators. Shadow banks range from hedge funds to private-equity firms and are bank-like but not overseen by bank regulators. Some fear they could cause the next financial crisis. Many of Donald Trump’s advisers, including Treasury Secretary Steven Mnuchin and the National Economic Council head, Gary Cohn, have worked in shadow banks. And Trump’s pick for Federal Reserve chair, Jerome Powell, is a former private-equity executive.
This is a weird one: Treasury Secretary Steven Mnuchin, a former Goldman Sachs banker and hedge fund manager, wants to ban the widely used term “shadow banking.”
First coined by the former Pimco economist Paul McCulley, the term refers to a wide swath of financial activities that occur at firms that are not commercial, deposit-taking banks. Because the behavior of such entities, which include hedge funds and private-equity firms, is bank-like but not overseen by bank regulators, many experts worry the sector could become the next candidate for a financial crisis now that rules on actual banks have been tightened.
Before the financial crisis, investment banks like Goldman Sachs and Morgan Stanley – not to mention Lehman Brothers and Bear Stearns – were shadow banks themselves, which is a big reason regulators missed their most egregious financial misdealings. But those firms were forced to adopt commercial-banking charters to receive taxpayer bailouts during the 2008 meltdown.
Now, in a downright Orwellian move, the Treasury has issued a report saying that despite its widespread use among both industry participants and regulators, the term “shadow banking” should be gotten rid of. The report was authored by Mnuchin, a former hedge fund exec, and Craig Phillips, a counselor to the Treasury secretary who previously was a top executive at the fund giant BlackRock, one of the firms that are often referred to as shadow banks.
“Treasury prefers to transition to a different term, ‘market based finance,'” the report said. “Applying the term ‘shadow banking’ to registered investment companies is particularly inappropriate as the word ‘shadow’ could be interpreted as implying insufficient regulatory oversight, or disclosure.”
That’s sort of the point – many of these entities are regulated in a loose sense, and their registration and reporting requirements are minimal, unlike those of actual banks and other mainstream financial institutions.
In a recent New York Times Q&A, McCulley was asked about the Treasury’s proposed change.
“A fiery run on the shadow bank Lehman Brothers triggered the financial crisis,” he said. “Our government had no choice but to rescue, then transform, Lehman’s too-big-to-fail shadow bank brethren into conventional banks, with access to the government’s safety nets.”
But that access came at the cost of “the same regulatory restrictions as conventional banks, reducing the fun and profitability of their shadow banking game.”
As memories of the crisis fade, McCulley fears that President Donald Trump’s effort to re-deregulate the financial system could take it back to its precrisis state of fragility.
“I don’t worry about efforts to take the term shadow banking out of the lexicon. I actually use the term ‘market-based finance’ myself frequently,” McCulley said.
“I do worry, however, about what the erase-it effort represents: a cyclical turn to regulators once again being enthralled along with captured by the regulated.”
Trump ran for president on an anti-Wall Street platform but quickly surrounded himself with bankers, including Gary Cohn, the former Goldman Sachs president who is now head of the National Economic Council. And Trump’s pick for Federal Reserve chair is a former private-equity executive, the current Fed board governor Jerome Powell.