Some financial industry critics blame the so-called shadow banking system for many of the problems that occurred leading up to the 2008 crisis. The growth of non-depository financial firms with weak regulatory oversight may have resulted in excessive risk-taking. A few commonly cited examples include the very high leverage at failed investment banks like Bear Sterns and Lehman Brothers and the unregulated credit default swap market that caused big problems for AIG. Might the shadow system return, and if it does, can regulators do better?
Floyd Norris of the New York Times reports that Citigroup CEO Vikram Pandit worries that Basel III's new capital requirements could cause a new shadow system. At a conference this week, Pandit said:
Any time the amount of capital required by regulation exceeds the levels judged necessary by the market, opportunities for arbitrage arise. It probably won't be mortgage brokers who fuel the next bubble. But some unregulated financial niche will arise, posing similar -- or greater -- dangers.
Of course, the natural response to this comment is that the market isn't likely to judge that the new capital requirements are excessive. Even some of the most pure free marketers agree that higher capital and liquidity levels than what were in place before the crisis are desirable, just ask former Fed Chief Alan Greenspan.