The Role of the Shadow Banking System in the Inflation Debate

Ellen Brown has an interesting analysis on the effect of the shadow banking system on the inflation debate (edited for brevity):

In a Washington Times article titled “Banks Still Standing Amid Credit Rubble,” Patrice Hill wrote:

“Before last fall’s financial crisis, banks provided only $8 trillion of the roughly $25 trillion in loans outstanding in the United States, while traditional bond markets provided another $7 trillion, according to the Federal Reserve. The largest share of the borrowed funds - $10 trillion - came from securitized loan markets that barely existed two decades ago. . . .

Mr. Regalia [chief economist at the U.S. Chamber of Commerce] said ... 70 percent of the system isn’t there anymore,’ he said.”

Seventy percent of the system isn’t there anymore because the traditional bond markets and securitized loan markets have dried up. Writes Hill:

“Congress’ demand that banks fill in for collapsed securities markets poses a dilemma for the banks, not only because most do not have the capacity to ramp up to such large-scale lending quickly. The securitized loan markets provided an essential part of the machinery that enabled banks to lend in the first place. By selling most of their portfolios of mortgages, business and consumer loans to investors, banks in the past freed up money to make new loans. . . .

“The market for pooled subprime loans, known as collateralized debt obligations (CDOs), collapsed at the end of 2007 and, by most accounts, will never come back. Because of the surging defaults on subprime and other exotic mortgages, investors have shied away from buying the loans, forcing banks and Wall Street firms to hold them on their books and take the losses.”

Brown shows - as Mish, Tyler Durden and others have - that the amount of wealth destroyed is far greater than the amount of money the feds are pumping into the system. She also shows that the shadow banking systems CDO market dwarfed other loan considerations, and argues that the collapse of the CDO market means that deflation will - with certainty - continue to trump inflation unless and until one of the following 2 things happen:

1. The fed monetizes the debt on a much bigger scale than it is currently doing, or
   
   
2. The government reclaims its power to print money itself (see this and this)
   

And see this.