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Shadow Banking: The $67 Trillion Threat to the U.S. Economy

November 25, 2012
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Source: Daily Finance

Shadow banking. The name alone sounds ominous -- like some dangerous phantom biding its time, waiting for the perfect moment to leap from its hiding place to do its deadly work.

On a financial level, that metaphor actually works pretty well.

The shadow banking system does exist in the shadows, away from the spotlight of regulation we've come to expect banks to operate within. And given the right conditions, it could leap unexpectedly from its dark, financial hiding place and bring the U.S. economy to its knees, just like it nearly did in 2008.

An Honor We'd Rather Not Hold

What's bringing this issue to the forefront again is a new report by the Financial Stability Board, an international financial-standards advisory group. It cites that assets held in the global shadow banking system hit a new high last year: $67 trillion, which comes out to about half the world's total banking assets.

In the report, the FSB formally describes the shadow banking system as "credit intermediation involving entities and activities outside the regular banking system." Translated into English, this means the act of borrowing, lending, or otherwise shifting of money around by financial institutions that aren't subject to regulation, like hedge funds. It can also refer to traditional banks operating in largely unregulated arenas such as credit-default swaps.

America's portion of this $67 trillion in global assets is $23 trillion. In terms of total share, that's a decrease from 44 percent in 2005 to 35 percent in 2011 -- still enough to give the U.S. the dubious honor of having the world's largest shadow banking system, and more than enough to put the entire U.S. economy at risk of another credit freeze.

That's the danger here: Without the smooth flow of cash and credit, the lifeblood of any free-market system, economic life grinds to a halt.

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