Shadow Banking! Liquidity! Bailouts! : Planet Money A lot of the financial-reform debate in Congress right now is about how -- and how much -- to regulate the shadow banking system. But a few pieces out this week point to possible gaps in current reform plans.
NPR logo Shadow Banking! Liquidity! Bailouts!

Shadow Banking! Liquidity! Bailouts!

"Shadow banking" sounds secretive and risky. It is.

Basic commercial banking -- taking deposits and making loans -- is only one piece of the financial system. Trillions of dollars flow through other, largely unregulated channels known as the shadow-banking system. For example, during the boom, investment banks bought securities backed by home mortgages, then used those securities as collateral to borrow money.

During the crisis, the government made it clear it would bail out failing pieces of this shadow-banking system. So now the shadow bankers have a government guarantee, but still don't face the kind of regulation that applies to traditional banks.

A lot of the financial-reform debate in Congress right now is about how -- and how much -- to regulate the shadow banking system. But a few pieces out this week point to possible gaps in current reform plans.

The Economist says money-market funds should either make it clear that investors could lose money, or be required to set more money in reserve and pay for insurance against losses.

And Bloomberg News points out that just holding capital in reserve isn't enough -- financial institutions need to be holding capital they'll be able to sell even during a crisis.

A big problem during the recent crisis was that some companies -- like Bear Stearns -- were holding mortgage-related assets that they were unable to sell when things started to get crazy.If they had been holding cash or Treasuries instead, they would have made lower profits during the boom, but would have had a better shot at surviving the bust.