While the term "the Great Recession" has been loosely applied to almost every economic downturn in the past twenty years, the crisis of 2007-09 has--more than most recessions--lived up to that name. (1) The crisis has been felt across virtually all economic sectors and in all parts of the world. Still, if its effects have been widespread, its origins were narrower: the crisis had its roots in the financial sector and manifested itself first through disruptions in the system of financial intermediation.
This story is in itself not new. Many economic crises in history have been the result of financial crises, and many financial crises in turn originated as failures of financial intermediaries. And in every instance the reference has been to banks, in their essential role as deposit-taking entities involved primarily in the business of lending. Thus, Reinhart and Rogoff (2008) identify some thirty separate instances of banking crises across many countries and at different points in time during the last 100 years.
Indeed, the terms bank and financial intermediary have normally been used interchangeably. However, what was new in this last crisis is that we witnessed many instances of financial intermediation failure that did not necessarily, or at least not directly, result from bank failures. To be sure, many banks did indeed fail during the crisis and many more were left with impaired operations--outcomes that certainly exacerbated the scale and scope of the crisis. Nevertheless, major disruptions occurred among segments of financial intermediation activity that had in recent years been growing rapidly and that did not seem to revolve around the activity and operations of banks.
For instance, we have learned that the crisis originated as a run on the liabilities of issuers of asset-backed commercial paper (ABCP), a short-term funding instrument used to finance asset portfolios of long-term maturities (see, for example, Gorton ; Covitz, Liang, and Suarez ; Acharya, Schnabl, and Suarez [forthcoming]; and Kacperczyk and Schnabl ). In this sense, ABCP issuers (conduits) perform typical financial intermediation functions, but they are not banks. Certainly, in many instances banks were the driving force behind ABCP funding growth, sponsoring conduit activity and providing the needed liquidity and credit enhancements. But the main point is that ABCP financing shifts a component of financial intermediation away from the traditional location--the bank's own balance sheet. Similarly, and concurrently with the ABCP disruptions, financial markets also witnessed a bank-like run on investors that funded their balance sheet through repurchase agreement (repo) transactions, another form of financial intermediation that grew rapidly but did not take place on bank balance sheets (Gorton 2008; Gorton and Metrick 2010). Additionally, in the aftermath of Lehman Brothers' default, money market mutual funds, yet another class of nonbank entities that serve as financial intermediaries, experienced a run on their liabilities, an event that triggered in turn an even bigger run on ABCP issuers (Acharya, Schnabl, and Suarez, forthcoming).
The crisis has therefore exposed significant instances of financial intermediation failure but also an apparent disconnect between financial intermediation activity and banks. A new narrative has emerged, describing intermediation as a decentralized rather than a bank-centered system, one in which the matching of the supply of and demand for funds occurs along an extended credit intermediation chain, with specialized markets and nonbank institutions playing a part along the way.
This is the so-called shadow banking model of financial intermediation, as described, for instance, in Pozsar et al. (2010). (2) The authors characterize the transition from a bank-centered to a decentralized model in this way: "In essence, the shadow banking system decomposes the simple process of deposit-funded, hold-to-maturity lending conducted by banks into a more complex, wholesale-funded, securitization-based lending process that involves a range of shadow banks" (p. …