Tens of thousands of houses are now owned by private investment companies. Commercial real estate projects are being financed by traditional lenders like real estate investment trusts. However, private-equity investors are bidding for and obtaining stakes in commercial real-estate loans.
Master Limited Partnerships are fueling growth in the energy industry. Mortgage bankers have arisen from the dust to fund the residential housing industry. Automobile lenders are now seeking public listings because of their need for funds to meet the demand for their services.
High-frequency traders are now providing the liquidity in the markets — liquidity that was once made available by specialists on now virtually defunct organizations like the New York Stock Exchange. Private-equity funds and hedge funds add more liquidity through proprietary trading. Plus, large foreign banks have entered the markets adding liquidity. The only entities not allowed to play are the U.S. banks.
Consumer-oriented lenders are also benefiting. There are payday-loan companies and pawn companies that are providing low income consumers with the funds they once acquired from banks. Consumer-finance companies are sure to rise in the vacuum created by the regulators in this sector.
As long as the economy rises, and I feel very positively that it will for the next few years, these companies will flourish. They will be funded by the growing desire by holders of money to put it to work at higher returns than are available from the traditional regulated banking industry. Investors are well advised to seriously consider these new companies for potential investment.
However, the safeguards that were in effect in the old-time banking industry are not in effect in this new unregulated financial market. I call it the old-time banking industry because in the newly regulated banking industry the safeguards have been removed. The Fed cannot aid a failing bank, it must help dismantle it. A strong bank cannot help a weak bank. It will be sued if it does this. Banks cannot help troubled non-bank financial companies.There are strict regulations that penalize them for doing this.
There will not be any new money source for the non-bank financial company that may be weakened by the next recession. The opposite will occur and these companies will fail throwing assets on to the market. This will destabilize the system.
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America now has a new financial system. It is driven by excessive regulation on one side and a complete laissez faire system on the other. Good times are expected for the next few years in the creation of unregulated non-bank financial companies. However, winter will come, as it always does, and the grasshoppers will freeze when it does.
Commentary by Richard X. Bove, an equity research analyst at Rafferty Capital Markets and the author of "Guardians of Prosperity: Why America Needs Big Banks" (2013).