The “Shadow Banking System” describes a wide variety of unregulated lenders. There is actually a Structured Finance Association that represents players in one part of the credit market that bundles together pools of loans that are then used to back tiers of bonds of different credit ratings. These derivatives had a central role in the 2008-09 financial crisis because the bundled derivatives were often rated much higher than the weak loans inside them.

Many METARs (like other investors) tend to focus on the stock market. But it’s actually the debt that inflates asset values which can evaporate like morning mist and pull down entire enterprises, including the Shadow Banks themselves. These debts can be interlinked and can unravel like pulling yarn in a knitted sweater. That’s what happened in 2008.

The Federal Reserve tracks junk bond market spreads relative to Treasuries. It happens to be rising at the moment but it’s still within the channel that has been stable since 2022.

St. Louis Fed (FRED): ICE BofA CCC & Lower US High Yield Index Option-Adjusted Spread (BAMLH0A3HYC) | FRED

The debt handled by the Shadow Banking system is only partially reflected in the Fed’s statistics. Many of the loans and derivative deals aren’t tracked.

wsj.com - Wall street intensifies scrutiny of fraud after spate of loan losses

Wall Street Intensifies Scrutiny of Fraud After Spate of Loan Losses
Lenders are increasing due diligence and demanding access to more data

By Sam Goldfarb and Soma Biswas, The Wall Street Journal, Nov. 3, 2025

Alleged corporate-borrower frauds are prompting Wall Street to increase due diligence and demand more financial data from companies.

A task force of banking, investment-management and accounting firms is examining the nature of the problem and investor protection.

Recent alleged frauds, including First Brands and Tricolor, have affected regional banks and Wall Street giants, raising concerns about systemic issues.

One industry group, the Structured Finance Association, convened a “Fraud Mitigation Task Force,” which will meet regularly over the next few months with the goal of presenting findings at a conference in late February….

the new task force will focus on what types of fraud lenders should be looking for and what processes they should follow to detect them—findings that could be relevant to other types of lending. The effort will include representatives from across SFA’s membership, which includes Wall Street banks, asset managers and the big four accounting firms…. [end quote]

There are two issues here.

One is outright fraud, e.g. company may get a loan based on receivables that don’t actually exist or overvalued collateral. The study group will focus on how to delve into the business and records of borrowers to make sure they are honest and not committing fraud.

The other is Macroeconomic-related problems, such a rising subprime defaults as the economy slows or zombie companies forced to roll over low-interest loans at higher rates.

The 2008 financial crisis was foreshadowed by “covenant-lite” loans (where lenders didn’t force borrowers to agree to limit their borrowing) and “PIK” or payment-in-kind loans where borrowers were allowed to pay interest with new debt instead of cash.

Hopefully the working group will discuss all that. The last thing the markets need is a replay of 2008.

On the other hand…as Jamie Damon said…where there’s one cockroach there’s probably a bunch more.

Wendy