In the old days, if you needed money you went to a bank. They might loan you money for your home, your car, or your business based on an interest rate slightly higher than the net paid out for deposits. They made their money on the “spread” between the two, matching up assets they had with liabilities (like you) outstanding. It was a quiet, conservative life. It was boring.
Today, most loans wind up not being held by banks in anything like the traditional sense. Nearly all liabilities are packaged up and sold to a “shadow banking” system where people buy these “asset backed securities” and make money based on the float. It’s a more flexible system that allows nearly all risk to be offloaded onto investors – who bear it as a system. It’s good for the borrower, it’s good for the bank – but the risk is held by the investment world as a whole.
That “brittleness” is the bane of the modern financial world – and the future. How we learn to manage it is the future of finance and the difference between a world that is stable and reliable or capricious and impossible to understand.
Barataria - The work of Erik Hare 