The size of the "Shadow Banking" system must be huge. More off-balance sheet problems for financial conglomerates.
In an unusual move, banks such as Citigroup, JPMorgan Chase and Bank of America have come to the rescue of the off-balance-sheet vehicles that help them to fund credit card loans.
Issuers typically sell their credit card loans to trusts which in turn sell bonds to investors. The banks retain a small interest and manage the trust.
There limits to the amount of liquidity and leverage an economy can absorb but "Too Big" conglomerates don't care because the need the fees and returns to survive. I digress.
The problem for the financial conglomerates is that these off-balance sheet trusts are starting to lose money fast. Any cushion or reserves are being eaten up by mounting credit card defaults.
For example, BofA, Citi and American Express have issued, and bought, new bonds that would absorb the first wave of losses in the trusts, in an effort to provide existing bondholders with an additional layer of protection.
Got that - more leverage in an overly leveraged system. But hey, "Stress Tests" said the financial conglomerates were OK. Who are we to question their "zombie" status? After all the financial conglomerates are using innovated means to combat this problem such as the use of "discount option".
This allows issuers to divert some of cardholders' incoming principal payments into the fund that pays out bondholders and covers losses.
This temporarily eats into lending capacity but creates the appearance of higher yields for the trust and helps it avoid hitting triggers that would force it to repay bondholders early.
While most credit card securitisations are still well above such triggers, banks have a strong incentive to provide support before accelerating credit card losses put the trusts in the danger zone.
The financial conglomerates are using this ploy to cover-up how bad the situation truly is. But the financial conglomerates have a bigger problem in the form of an accounting rule change. Financial Accounting Standard will in January require banks to move off-balance sheet vehicles such as these credit card trusts and move them on to their balance sheets. This will force them to increase their capital reserves.
It is a shame we have to wait until January 2010 to shed light on this "Shadow Banking" system and just think it is not the Obama Administration or the Fed that (actually they hate the idea) is improving financial reporting transparency - it is accountants.