The next scapegoat

Fund managers may not realise it but they are already being set up as scapegoats for the next financial crisis. Banks got most of the blame for the 2008-9 crisis, and were severely criticised for their role in the eurozone’s troubles, but it looks like asset managers could be next.

Just look at the latest edition of the twice-yearly Global Financial Stability Report from the International Monetary Fund (IMF). Although the discussion is under the heading of shadow banking, with a whole chapter devoted to the topic, it makes it clear that this includes asset managers. It leaves no doubt that fund management is seen as a potential source of future financial instability.

For those unfamiliar with the jargon the term shadow banking is defined as credit intermediation outside the conventional banking system. Sources of such credit can include investment funds – particularly bond funds and money market funds – and insurance companies.

Shadow banking has become more important recently at least partly because of the tightening of bank regulation. If banks are less able or willing to lend it is not surprising that corporates turn to other sources. For example, firms can circumvent traditional borrowing by issuing bonds that are in turn purchased by investment funds.

By some measures this trend is particularly pronounced in Britain. The IMF estimates that shadow banking assets account for more than twice the share of GDP than in any other area.

From a regulator’s perspective the rise of shadow banking is a problem as it is less tightly regulated than conventional banking and lacks a formal safety net. New forms of credit intermediation therefore increase systemic risks. As the report argues: “Continued financial risk taking and structural changes in credit markets have shifted the locus of financial concerns from the banking system to the shadow banking system—particularly to asset managers— thereby increasing market and liquidity risks.”

The inevitable conclusion drawn from this discussion is that shadow banking needs to be more tightly regulated. Collecting additional data is posed as the first stage of this process but there is no doubt it will go further.

Much of this may sound like common sense but it would be wise to be more wary. Bankers were in many ways set up as scapegoats for the last financial crisis. Politicians in particular were keen to one-sidedly focus on the role of banks in the inflation of the preceding financial bubble.

This is not to argue that bankers were entirely innocent. Clearly they played a role. But what has become the conventional narrative focuses far too much on them and far too little on the role of government and central bankers. For instance, easy credit also played a role in the creation of the bubble. More fundamental structural weaknesses of the economy also tend to be downplayed.

Recent history should put the current discussion of the dangers of shadow banking in a different light. Technocrats and politicians are keen to get their retaliation in first rather than accept any blame for future economic difficulties.

Fund managers have been warned.

This blog post was first published today on Fundweb.