Big Banks’ Shadow Dance

One of the great myths propagated by large financial institutions is that proper regulation would drive many investors to “shadow banks.” In reality, there are three kinds of “shadow” activities, all of which are obvious, operate in plain sight, and could be controlled in a straightforward and responsible fashion.

WASHINGTON, DC – One of the great myths propagated by very large financial institutions is that, if they were to become effectively regulated again, many investors and financial transactions would flee to “shadow banks.”

That sounds bad. Anything that lurks in shadows must have nasty intent, potentially dangerous consequences, or both. And its very shadowiness implies that nothing can be done about it – whatever is there must be beyond the reach of regulation or effective supervision. So perhaps financial-system risk would increase, not decrease, if we regulated very large non-shadow banks properly.

So much for scary fairytales. In reality, there are three kinds of “shadow” activities, all of which are obvious, operate in plain sight, and could be controlled in a straightforward and responsible fashion. Whether we have the political will to implement effective controls is, as always, another question – in large part because the big banks are very powerful and they would like the shadows to remain as shadowy as they are now.

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