A decade after reckless home lending nearly destroyed the financial system, the business of making risky loans is back.
This time the money is bypassing the traditional, and heavily regulated, banking system and flowing through a growing network of businesses that stepped in to provide loans to parts of the economy that banks abandoned after 2008.
It is called shadow banking, and it is a key source of the credit that drives the U.S. economy. With almost $15 trillion in assets, the shadow-banking sector in the United States is roughly the same size as the entire banking system of Britain, the world’s fifth-largest economy.
In certain areas — including mortgages, auto lending and some business loans — shadow banks have eclipsed traditional banks, which have spent much of the last decade pulling back on lending in the face of stricter regulatory standards aimed at keeping them out of trouble.
But new problems arise when the industry depends on lenders that compete aggressively, operate with less of a cushion against losses and have fewer regulations to keep them from taking on too much risk. Recently, a chorus of industry officials and policymakers — including the Federal Reserve chair, Jerome Powell, last month — have started to signal that they’re watching the growth of riskier lending by these nonbanks.
“We decided to regulate the banks, hoping for a more stable financial system, which doesn’t take as many risks,” said Amit Seru, a professor of finance at the Stanford Graduate School of Business.
“Where the banks retreated, shadow banks stepped in.”
With roughly 50 million residential properties, and $10 trillion in amassed debt, the U.S. mortgage market is the largest source of consumer lending on Earth.
Lately, that lending is coming from companies like Quicken Loans, loanDepot and Caliber Home Loans.
Is this a good thing? If you’re trying to buy a home, probably. These lenders are competitive and willing to lend to borrowers with slightly lower credit scores or higher levels of debt compared to their income.
The downside of all this? Because these entities aren’t regulated like banks, it’s unclear how much capital — the cushion of nonborrowed money the companies operate with — they have.
For now, such defaults remain quite low.
In recent weeks, warnings about the market for collateralized loan obligations and leveraged loans have been multiplying. Last month, Powell said the Fed was closely monitoring the buildup of risky business debt, and ratings agency Moody’s noted this month that a record number of companies borrowing in the loan markets had received highly speculative ratings that reflected “fragile business models and a high degree of financial risk.”