Tito's Blog

What Are Central Banks Doing?

James Saft sheds some light on the current state of the securitization world: The state-sponsored shadow banking system.

Banks now lend money to homebuyers, businesses and consumers, turn those loans into securities, park the security with a friendly central bank and get cash back, thus allowing them to effectively take on more risk and continue lending despite balance sheet pressure.

I am not sure central banks will get us out of this mess, as banks now have even more incentives to play Russian roulette for survival, in a situation that reminds me of the agency costs of debt overhang.

The banks, for their part, are engaged in a Darwinian all-or-nothing bet. If they stop lending they are probably toast anyway, so may as well lend and hope that they are amongst the survivors and can then grow rich on fat margins.

Remember that there is still $175.8 trillion in notional value of derivatives held by US institutions ready to explode. I really think that the fiat currency system that fed the world expansion phase of the past 40 years (since the Bretton Woods system came to an abrupt end in 1971) is at risk. This morning I started buying gold and gold mining companies stock.