Shadow Banking System

A global stock market crash has begun. European stocks are crashing, Chinese stocks are crashing, and commodities are crashing. And guess what? All of those things happened before U.S. stocks crashed in the fall of 2008 too. In so many ways, it seems like we are watching a replay of the financial crisis of 2008, but this time around the world is in far worse shape financially. Global debt levels are at an all-time high, the 75 trillion dollar global shadow banking system could implode at any time, and there are hundreds of trillions of dollars in derivatives that threaten to wipe out major banks all over the planet. The last major worldwide financial crash was almost seven years ago, and very little has been done since that time to prepare for the next one. If global markets do not calm down, we could see carnage in the months ahead that is absolutely unprecedented.

For months, European authorities have been promising us that a “Grexit” is already “priced in” to the markets and that any “contagion” from the Greek crisis will be “contained”. Of course everyone knew that was just a smokescreen. Just in the past couple of days since the Greek “no” vote, European stocks have already been crashing. The following comes from Zero Hedge…

Does this look contained to you?

Portugal, Spain, and Italy all collapsing…

As I mentioned at the top of this article, European stocks started crashing well before U.S. stocks started crashing during the last financial crisis. If you doubt this, just look at this chart, and this chart and this chart.

Will the same thing happen again this time?

And just like I have warned repeatedly, European bond yields have started to soar. When bond yields go up, bond prices go down, so many bond investors are losing a tremendous amount of money right now. Here is more from Zero Hedge…

Who’s next?

European bond risk is anything but “contained” as GGB 10Y Yields top 18%…

If there is not a last minute deal between Greece and her creditors, what we have witnessed so far in the bond markets will just be the tip of the iceberg. In the months ahead, we could witness a bond crash unlike anything that we have ever seen in all of history. Just consider what Egon von Greyerz recently told Eric King…

There is no liquidity in this market and this is where we will soon see a problem. We will see the bond market totally seizing up in the next few months. Eric, people simply don’t understand that this is a much bigger problem than Greece.

So we are talking about a worldwide problem, not just a Greek problem. The majority of the $100 trillion bond market is worthless, and of course a ticking time-bomb of over $1 quadrillion worth of derivatives is linked to that. This means that, sadly, we are heading into a major contagion that will lead to financial catastrophe for the world. This will also lead to an implosion of all bubble assets across the globe.

Hmm – there is that word “derivatives” again.

It is funny how that keeps popping up.

As things unravel over in Europe, a lot of desperate Europeans are feverishly purchasing physical gold. The following comes from Bloomberg…

European investors are increasing purchases of gold as Greece’s turmoil boosts the appeal for an alternative to the euro.

Demand from Greek customers for Sovereign gold coins was double the five-month average in June, the U.K. Royal Mint said in an e-mailed statement. CoinInvest.com, an online retailer, said sales on Saturday and Sunday were the highest since Cyprus limited cash withdrawals in 2013, driven by a jump in German, French and Greek buyers.

Investors are searching for a safe haven after Greece imposed capital controls, closed banks and stopped selling gold coins to the public until at least July 6.

Meanwhile, Chinese stocks have continued to fall. Overall, Chinese stocks have fallen 27 percent since the peak, and a whopping 3.2 trillion dollars of “paper wealth” has been wiped out in China in just the last three weeks.

At this point things are so bad that about one-fourth of all stocks in China have already suspended trading according to CNN…

The turmoil in China’s stock market is so bad that some companies are calling it quits.

Over 700 Chinese companies have halted trading to “self preserve,” according to the state media. That means about a quarter of the companies listed on China’s two big exchanges — the Shanghai and Shenzhen — are no longer trading.

Desperate measures are being employed to try to stop the stock market crash in China. For example, over the weekend an alliance of securities brokerages pledged to invest “at least 120 billion yuan” in order to stabilize stock prices…

China’s top 21 securities brokerages said on Saturday they would collectively invest at least 120 billion yuan ($19.3 billion) to help stabilize the country’s stock markets after a slump of nearly 30 percent since mid-June. In addition, 57 Chinese mutual funds are reportedly investing 2.2 billion yuan in stock funds.

The Chinese central bank has gotten involved as well. In fact, the People’s Bank of China has taken the dramatic step of actually directly loaning money to brokerages…

In an extraordinary move, the People’s Bank of China has begun lending money to investors to buy shares in the flailing market. The Wall Street Journal reports this “liquidity assistance” will be provided to the regulator-owned China Securities Finance Corp, which will lend the money to brokerages, which will in turn lend to investors.

The dramatic intervention marks the first time funds from the central bank have been directed anywhere other than the banks, signalling serious concern from authorities about the crisis.

In addition, the Chinese government has taken the following steps to intervene…

-All short selling of stocks has been banned.

-China’s national social security fund has been banned from selling stocks, but they can continue to buy stocks.

-Local media has been banned from using the terms “equity disaster” and “rescue the market” in their news reports.

But despite everything that you just read, Chinese stocks have still been falling.

Meanwhile, global commodity prices are crashing. Just check out this chart. This is also something that happened before U.S. stocks crashed back in 2008.

Thankfully, U.S. stocks have not started crashing yet. But it should be noted that the “smart money” in the United States has been selling stocks like crazy since the “no” vote in the Greek referendum. And if the patterns that we witnessed seven years ago hold up, it is just a matter of time before we experience a stock market crash too.

Incredibly, there are a lot of people out there that very strongly believe that everything is going to be just fine. They have tremendous faith in the central bankers and in our political leaders, and they are assuring all the rest of us that there is no possible way that the global financial system could be brought down again.

I truly wish that they were right. If everything was going to be just fine, instead of writing about the coming economic collapse I could write about sports or do a blog dedicated to LOLcats. But of course the truth is that the “hopetimists” are dead wrong.

A great shaking is coming to our world, and life as we know it is about to change in a major way.

Keep an eye on the shadow banking system – it is about to be shaken to the core. According to the Financial Stability Board, the size of the global shadow banking system has reached an astounding 75 trillion dollars. It has approximately tripled in size since 2002. In the U.S. alone, the size of the shadow banking system is approximately 24 trillion dollars. At this point, shadow banking assets in the United States are even greater than those of conventional banks. These shadow banks are largely unregulated, but governments around the world have been extremely hesitant to crack down on them because these nonbank lenders have helped fuel economic growth. But in the end, we will all likely pay a very great price for allowing these exceedingly reckless financial institutions to run wild.

If you are not familiar with the “shadow banking system”, the following is a pretty good definition from investing answers.com…

The shadow banking system (or shadow financial system) is a network of financial institutions comprised of non-depository banks — e.g., investment banks, structured investment vehicles (SIVs), conduits, hedge funds, non-bank financial institutions and money market funds.

How it works/Example:

Shadow banking institutions generally serve as intermediaries between investors and borrowers, providing credit and capital for investors, institutional investors, and corporations, and profiting from fees and/or from the arbitrage in interest rates.

Because shadow banking institutions don’t receive traditional deposits like a depository bank, they have escaped most regulatory limits and laws imposed on the traditional banking system. Members are able to operate without being subject to regulatory oversight for unregulated activities. An example of an unregulated activity is a credit default swap (CDS).

These institutions are extremely dangerous because they are highly leveraged and they are behaving very recklessly. They played a major role during the financial crisis of 2008, and even the New York Fed admits that shadow banking has “increased the fragility of the entire financial system”…

The current financial crisis has highlighted the growing importance of the “shadow banking system,” which grew out of the securitization of assets and the integration of banking with capital market developments. This trend has been most pronounced in the United States, but it has had a profound influence on the global financial system. In a market-based financial system, banking and capital market developments are inseparable: Funding conditions are closely tied to fluctuations in the leverage of market-based financial intermediaries. Growth in the balance sheets of these intermediaries provides a sense of the availability of credit, while contractions of their balance sheets have tended to precede the onset of financial crises. Securitization was intended as a way to transfer credit risk to those better able to absorb losses, but instead it increased the fragility of the entire financial system by allowing banks and other intermediaries to “leverage up” by buying one another’s securities.

Over the past decade, shadow banking has become a truly worldwide phenomenon, and thus it is a major threat to the entire global financial system. In China, shadow banking has been growing by leaps and bounds, but this has the authorities deeply concerned. In fact, according to Bloomberg one top Chinese regulator has referred to shadow banking as a “Ponzi scheme”…

Their growth had caused the man who is now China’s top securities regulator to label the off-balance-sheet products a “Ponzi scheme,” because banks have to sell more each month to pay off those that are maturing.

And what happens to all Ponzi schemes eventually?

In the end, they always collapse.

And when this 75 trillion dollar Ponzi scheme collapses, the global devastation that it will cause will be absolutely unprecedented.

Bond expert Bill Gross, who is intimately familiar with the shadow banking system, has just come out with a major warning about the lack of liquidity in the shadow banking system…

Mutual funds, hedge funds, and ETFs, are part of the “shadow banking system” where these modern “banks” are not required to maintain reserves or even emergency levels of cash. Since they in effect now are the market, a rush for liquidity on the part of the investing public, whether they be individuals in 401Ks or institutional pension funds and insurance companies, would find the “market” selling to itself with the Federal Reserve severely limited in its ability to provide assistance.

As far as shadow banking is concerned, everything is just fine as long as markets just keep going up and up and up.

But once they start falling, the whole system can start falling apart very rapidly. Here is more from Bill Gross on what might cause a “run on the shadow banks” in the near future…

Long used to the inevitability of capital gains, investors and markets have not been tested during a stretch of time when prices go down and policymakers’ hands are tied to perform their historical function of buyer of last resort. It’s then that liquidity will be tested.

And what might precipitate such a “run on the shadow banks”?

1) A central bank mistake leading to lower bond prices and a stronger dollar.

2) Greece, and if so, the inevitable aftermath of default/restructuring leading to additional concerns for Eurozone peripherals.

3) China – “a riddle wrapped in a mystery, inside an enigma”. It is the “mystery meat” of economic sandwiches – you never know what’s in there. Credit has expanded more rapidly in recent years than any major economy in history, a sure warning sign.

4) Emerging market crisis – dollar denominated debt/overinvestment/commodity orientation – take your pick of potential culprits.

5) Geopolitical risks – too numerous to mention and too sensitive to print.

6) A butterfly’s wing – chaos theory suggests that a small change in “non-linear systems” could result in large changes elsewhere. Call this kooky, but in a levered financial system, small changes can upset the status quo. Keep that butterfly net handy.

Should that moment occur, a cold rather than a hot shower may be an investor’s reward and the view will be something less than “gorgeous”. So what to do? Hold an appropriate amount of cash so that panic selling for you is off the table.

In order to avoid a shadow banking crisis, what we need is for global financial markets to stabilize and to resume their upward trends.

If stocks and bonds start crashing, which is precisely what I have projected will happen during the last half of 2015, the shadow banking system is going to come under an extreme amount of stress. If the coming global financial crisis is even half as bad as I believe it is going to be, there is no way that the shadow banking system is going to hold up.

So let’s hope that the financial devastation that we have seen so far this week is not a preview of things to come. The global financial system has been transformed into a delicately balanced pyramid of glass that is not designed to handle turbulent times. We should have never allowed the shadow banks to run wild like this, but we did, and now in just a short while we are going to get to witness a financial implosion unlike anything the world has ever seen before.

European Stocks, Chinese Stocks And Commodities Are All Crashing – Are U.S. Stocks Next?

The 75 Trillion Dollar Shadow Banking System Is In Danger Of Collapsing