shadow banks

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What the Financial Press isn't Telling You About China’s Subprime Crisis

China is the world's second-largest economy, a simple fact that underscores the importance of its financial health to investors worldwide.

And unfortunately, thanks to China's subprime crisis, it's not doing as well as we're led to believe.

The Chinese stock market has fallen to levels unseen since the 2009 global financial crisis, and short-term interest rates have reached as high as 25%.

We've been told by the mainstream financial press the Chinese economic crisis is being caused by shadow banking.

The term has been demonized by reporters outside China. But that's not the whole story. In fact, there is a valid reason for shadow banking to thrive in China:

"Chinese banks are mostly state-owned, and they rarely lend money to the private sector. Thus, there has always been strong demand for financing outside of official banking circles," says Money Morning Global Investing & Income Strategist Robert Hsu.

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$13 Trillion in Obligations Show Shadow Banks Still Threat to Financial System

A report issued by the Federal Reserve Bank of New York shows that so-called "shadow banks" still hold more obligations than regular banks, representing a continuing threat to the financial system.

Three years after the beginning of the financial crisis, the shadow banking system had about $16 trillion of obligations in the first quarter, compared with $13 trillion for banks, the report said. The gap has narrowed from 2008, when obligations were $20 trillion and $11 trillion, respectively.

Throughout the early part of the decade, shadow banks grew in importance as they acted as intermediaries between investors and borrowers.   Familiar examples of shadow institutions include Bear Stearns and Lehman Brothers, which were swallowed by the financial crisis, as well as Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).

While this system became a huge and vital source of money to fuel the housing market and the rest of the U.S. economy, the subprime mortgage crisis and ensuing credit crunch exposed a major flaw.

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