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The Jehoshua Novels


How Shadow Banks Rule the World

Der Spiegel, By Martin Hesse and Anne Seith

In the financial world, there is a narrow divide between heaven and hell. Frenchman Loïc Féry realized this when he was 33. He was a rising star in the banking world, managing the trade in complex loan packages for an investment bank. According to his business card, he was the bank’s “global head of credit markets.” But then one of his employees gambled away about €250 million ($317 million), and suddenly Féry was without a job.

That was in 2007. A number of investment bankers experienced a similarly precipitous fall in the turbulent years of the financial crisis. But, like Féry, many reappeared before long and became more successful than ever, in the world of the so-called shadow banks. These are companies that engage in business similar to that of ordinary banks, but without being subject to the same strict regulation.

Féry launched a hedge fund in London. These notorious investment firms collect money from customers and speculate with a wide range of securities. Today Féry makes the kinds of investments that are too risky for his former colleagues. He lends the money of his customers to companies whose creditworthiness isn’t good enough to qualify for loans from ordinary banks, and he also buys especially risky loan packages from lenders. As a result, he is able to achieve double-digit returns in the midst of a crisis.

But the Frenchman, who has become so successful that he was able to buy a first-division football club, FC Lorient, insists that companies like his make “a positive contribution to the real economy,” because they manage risks professionally.

Growing Concern About Lack of Regulation

But banks, regulators, politicians and economists are worried about the parallel universe that has developed beyond the major banks. Until the 2007 financial crisis, shadow banks grew at a pace similar to that of ordinary financial institutions. Hedge funds, special-purpose entities and money market funds benefited from the low interest rates offered by central banks. Banks increasingly used outside companies to handle all the deals that were too risky for them, so that they wouldn’t appear on their books. In this manner, shadow banks and regular banks collaborated to build a castle in the air made up of loans.

Within a few years, the volume of financial transactions in the world of shadow banks grew from $27 trillion to $60 trillion today. Now regulators finally want to clamp down and set up a regulatory framework that has so far been conspicuous by its absence for this sector.

After the financial crisis of 2008, German Chancellor Angela Merkel, of the center-right Christian Democratic Union (CDU), said that there could be no “blind spots” on the map of financial market regulation. But while more and more laws were passed to control banks, regulation of the shadow banks is only just beginning.

The man who is supposed to bring about the necessary change works in an office tower far away from major financial centers. When Svein Andresen broods over how he can best go about taming the wild masters of money, he sees the Black Forest through his office window. The level-headed Norwegian is the secretary general of the Financial Stability Board (FSB), which is housed at the Bank for International Settlements in Basel, Switzerland, the umbrella organization of the world’s central banks.

The FSB is intended to avert a repeat of disasters like the 2008 crisis. “For years, governments and regulatory agencies paid too little attention to financial institutions outside the world of banking,” says Andresen. Now he wants to bring order to the chaotic world of shadow banks. But it’s a slow process.

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