Your questions are the right ones. What are the liabilities of the lender? Regulated banks issue short term deposits which are either legally guaranteed by the govt (up to $250k etc) or defacto are. As in the guarantee either being extended to everybody directly (Silcion Valley Bank precedent since the GFC) or all the other indirect ways in the GFC, shoring up the banks' capital or the assets to insure the deposits.Exactly! This can’t really happen with a private credit firm if they simple owe their investors the value of the assets. That’s the difference with banks, which owe demand deposits that aren’t marked to the market of the banks assetsThat many of the world's leading financial institutions (in effect all of them, in early October 2008) were trading insolvent - assets worth less than their liabilities.
Like we never worry about VTI having “assets in excess of its liabilities.” It doesn’t even really make sense to say it. All it “owes” is the value of the assets
Banks have mark to market assets but demand deposits. A good ole fashioned bank run.
Basically “none” of it could have happened in a system of narrow banks plus debt financing (ie bonds)
"Systemic risk' really means losses which come back to roost at *regulated banks*. Which isn't limited to their lending to end users. And can be unpredictable. But not because entities outside the banking system have 'no oversight', but weakness in the oversight of *regulated banks* exposure to those entities. Class case, AIG FP (the derivative sub of the Insurance co) writing credit tail risk protection to lots of banks on synthetic loan/bond structures before GFC. Bank regulators could see bank by bank all the tail risk sitting in AIG from the banks' side of the transactions. You don't have to see both sides to know it's a mirror image. But they didn't do anything. 'If we'd have been regulating AIG FP we would have': joke. Same with the hedge fund LTCM and the 1998 Russia default. The systemic issue was credit extended by *banks* to LTCM. If banks didn't know what risks LTCM was taking, why lend to them, or why wouldn't bank regulators flag that on bank side?
Same here. To the extent Private Credit shops are (moderately) levered (compared to banks) and some of that lending is by banks to PC outfits there's a potential systemic issue. If not it's categorically different. It's not that investors can't lose megatons of money on investments banks didn't lend into, but it has a categorically lower risk to the financial system. That's why $8tril loss in the Nasdaq in 2000 had muted macro effect, and $tril+ losses in the ATSNBM in 2023 were barely noticed at all (ATSNBM system is basically parallel to the banking system, deliberately kept out of it, which may change, but debating that policy issue would lead off topic I think).
These crises are not because lenders pull back in face of losses/recession and borrowers 'can't refinance'. That's the business cycle. Regulation (of the intrusive form banks face*) is critical to protect the holders of assets de facto guaranteed by the govt, like (de facto, all) bank deposits. When those are threatened hell breaks loose. It's not to prevent loss of money on bad investments, even a lot.
*though US regulators will always going cut more breaks at the margin for the biggest US banks like JPM than smaller or foreign institutions in the US. They have more clout, simple as that.
Statistics: Posted by JackoC — Mon Jan 13, 2025 5:59 pm — Replies 53 — Views 5836