And perhaps the reason the reason they're doing that is that these retail investors
are very large investors.
They have a lot of money that would exceed
the levels that would be protected under insurance from the FDIC.
The retail investors hand dollars over to the money market mutual funds and,
technically, what they receive back are shares.
So a money market mutual fund is not technically a bank but
rather a fund that sells shares.
And they receive back those shares from the money market mutual fund.
And typically, and absolutely at this time for
retail investors, if you gave a dollar to a money market mutual fund,
they would just keep the value of your investment at a dollar at all times.
If the value of investment fell slightly below a dollar,
they were allowed to continue to say it was a dollar until it fell by too much.
If it fell by too much, then either the sponsor of the money market mutual fund
would themselves have to prop up the fund by putting money in, or they would have to
admit it had fallen below a dollar, something called breaking a buck.
That's something that really we would never see happen
until the financial crisis.
So our first step is similar in that we have retail investors
giving money to a financial institution.
But now the financial institution is a money market mutual fund,
which stands between the investors and, ultimately, some kind of bank.
So that's step two.
The money market mutual fund hands money over to the bank, and
the bank, what they give back to the money market mutual fund is no longer
a savings account or a checking account, but rather, they give back collateral.
And they give back collateral because were to say well, this is a checking account or
a savings account and you have an account with us now, it would not be insured.
Money market mutual fund that's making a deposit of $50 million or
$100 million with the bank, wants to make sure they're gonna get their money back.
And since insurance doesn't cover that, what they're gonna ask for is collateral.
And this transaction, in step 2, is something called the sales and
repurchase agreement or goes by the shorthand of just repo.
And in repo, effectively the money market mutual fund takes
legal title to the collateral, hands over the money, and
if they don't get their money back, they just keep their collateral.
This can happen through a variety of other steps as well.
For example, the bank may not have enough collateral
in order to give it over to the money market mutual fund.
What they have on their balance sheet perhaps are actual loans.
So what they do, in step 4, is they'll go back and forth
between securitization, which is what we studied earlier in an earlier module,
create from the raw material of the loans forms of asset-backed securities,
mortgage-backed securities,
that they can use as collateral, bring them back onto their balance sheet and
then exchange them for the money market mutual funds and repo in step 2.
They get those loans on their balance sheet in the first place by taking all
the dollars that they have received from the money market mutual funds in step 2,
and handing them over to borrowers in return for loans.
So, step 3, where banks are interacting with borrowers,
is identical to the step B that we see in this diagram, where banks and
borrowers are interacting in step B for loans.
In shadow banking, that step B becomes step 3, where loans and
dollars are being exchanged between banks and borrowers.
The banks now, however, instead of just keeping them on their balance sheets
are interacting with step 4 to create securitizations,
to receive back in return bonds, and to be able to use those bonds as collateral for
their money market mutual funds.