The Shadow Banking System and the Hearts of Men

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Conventional wisdom watch, bond market edition:

James Carville on the bond market, circa 1993: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

Karl Smith on the bond market, circa 2011: “I used to think if there was reincarnation, I wanted to come back as the bond market. But now I want to come back as the repo market. The repo market even intimidates the bond market.”

Karl didn’t actually say that, of course. But acting as his PR agent, I’m making his view a little more user friendly. In any case, he’s right. Sovereign bonds are the backbone of the repo market, and the repo market is the backbone of the shadow banking system. So when sovereign bonds fail, the shadow banking system fails and there’s a run. And as we all know, there’s no FDIC insurance for the shadow banking system.

At a guess, the shadow banking system makes up about half of the entire banking system these days, and right now the shadow banking system is looking distinctly wobbly in Europe. Somebody needs to prop it up to stop a run, and that somebody is the European Central Bank. So far, though, they aren’t stepping up to the plate. The best case scenario is that Noah Millman is right, and they’re just playing a very high-stakes game of chicken in order to advance German interests:

One way of looking at the sequence of events is to say that the ECB was willing to permit contagion in order to wring out inflation. I think a better way of looking at it is to say that the ECB was willing to threaten Italy with insolvency in order to give Germany more formal control over Italy’s finances. That’s incredibly hard-ball politics, but if you are not accountable to anybody (which the ECB, basically, is not) then you can play really, really hard-ball politics.

When somebody eventually makes a movie about this, perhaps it will be called Seven Days in December. I hope it has as happy an ending as the original.

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DEMOCRACY DOES NOT EXIST...

without free and fair elections, a vigorous free press, and engaged citizens to reclaim power from those who abuse it.

In this election year unlike any other—against a backdrop of a pandemic, an economic crisis, racial reckoning, and so much daily bluster—Mother Jones' journalism is driven by one simple question: Will America move closer to, or further from, justice and equity in the years to come?

If you're able to, please join us in this mission with a donation today. Our reporting right now is focused on voting rights and election security, corruption, disinformation, racial and gender equity, and the climate crisis. We can’t do it without the support of readers like you, and we need to give it everything we've got between now and November. Thank you.

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