Bill Gross, head of PIMCO, is credited with coining the term "Shadow Banking System". A few years ago he warned about its reckless behavior and how they could wreck the Economy.

Bill Gross Calls it "Shadow Banking System"
Bill Bonner, The Daily Reckoning Australia — Jan 22, 2008

Banks recognize that not all their loans will be repaid. They operate on margins of safety, with reserves set aside for when things go wrong. But in the worlds of swaps, hedge funds and derivatives…slick operators can invest billions with no margins of safety…and no reserves. The result, Gross says, could be catastrophic.

Turns out this blunt-speaking Mutual Fund Manager — WAS Right!

As we are now discovering from the current Senate Investigation, there was a slick system in place to fund those questionable Subprime Loans, with questionable Bonds from Shadowy Players on Wall Street, who would then pawn off these Ticking Time Bomb investments (CDO’s)– to Municipalities and Pension Funds all around the world — raking in an untold Profit. (And, Thanks to their bought-and-paid-for "AAA Stamp of Approvals" from equally shady Investment Rating Agencies — The World bought them — for the "pure gold" … they WEREN’T!)

In an earlier time — this would have been called a "Junk Bond Scandal" … today we just call it Derivatives and Securitization, and Buyer-Beware.

WaMu’s Gruesome Autopsy
by Andy Kroll, motherjones.com — Apr 13, 2010

The beginning of the end, as the Senate’s investigation suggests, came in 1999, when WaMu snapped up a subprime lender named Long Beach Mortgage Company. Long Beach was a major player in the booming securitization business — the origination of loans to be bundled into bonds backed by those pools of loans. These mortgage-backed securities were then sold to Wall Street banks and the two government-sponsored housing corporations, Fannie Mae and Freddie Mac.
[...]

Another key date, as the Senate investigation shows, was 2005, when WaMu and Long Beach, as shown in an internal WaMu PowerPoint presentation, settled on a strategy called "gain on sale." That strategy essentially stressed how much more profit could be made on riskier loans as opposed to government-backed, fixed interest-rate loans, and that these riskier, more profitable products–home equity, subprime, and option adjustable-rate mortgages–could be a cash cow for WaMu.

This cutthroat, purely profit-driven philosophy meant WaMu and Long Beach increasingly pushed their employees, in the early 2000s, to focus more on volume than quality–selling more and more loans with little regard for the underwriting or potential success of those loans. "WaMu built its conveyor belt of toxic mortgages to feed Wall Street’s appetite for mortgage backed securities," Levin said.

In addition to calling these underwriters "Too Big to Fail" — we should have called such High-risk Mortgage chop shops: "Too Shady to Trust"!

But they were selling us the American Dream – Too Bad, they failed to explain, that Dream had a "Gotcha Clause" … a Reset clause, which is STILL turning those Dreams, into Nightmares!

Was Bernie Madoff the Exception or the Rule?
Robert L. Bororsage — Apr 14, 2010

The Levin hearings show that WaMu systematically peddled loans to people it knew could not pay them back. This wasn’t an accident.
[...]

According to the FBI, 80% of mortgage fraud is committed by the lender. We’re not talking about stupid loan officers allowing borrowers to get away with something crazy that is bad for the bank. We’re talking about clever loan officers pushing fraudulent documents in order to score bigger paychecks, and bank executives looking the other way so that they can keep getting big paychecks from the securitization machine.

This isn’t a problem unique to WaMu. This is how the U.S. mortgage system operated for half a decade. WaMu particularly pushed predatory option-ARM loans, loans with an initial monthly payment so low that it often didn’t even pay off the interest on the loan. Then after a couple of years, the monthly payment explodes — and the loan becomes unaffordable.

All Ponzi schemes are built on some sort of Lie:

"We always beat the Market!"

"The Price of Housing will always Go Up."

"Don’t worry about that fine print — you’ll flip this House, WAY before that kicks in."

Loan Officers and Bank Presidents are trained professionals — average want-a-be Home Owners — ARE NOT!

We tend to be "easy marks" — to a gold-plated Banking System, playing outside the rules, and outside of any serious regulatory oversight.

Brokers threatened by run on shadow bank system
Regulators eye $10 trillion market that boomed outside traditional banking
7 Alistair Barr, MarketWatch — June 20, 2008

The shadow banking system grew rapidly during the past decade, accumulating more than $10 trillion in assets by early 2007. That made it roughly the same size as the traditional banking system, according to the Federal Reserve.

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

A $10 trillion shadow

Geithner also highlighted big brokerage firms, saying that their combined balance sheets held $4 trillion in assets in early 2007.

Hedge funds held another $1.8 trillion, bringing the total value of asset in the "non-bank" financial system to $10.5 trillion, he added.

That dwarfed the total assets of the five largest banks in the U.S., which held just over $6 trillion at the time, Geithner noted. The traditional banking system as a whole held about $10 trillion, he said.

The Stimulus, Krugman, and the Shadow Bankers.
by jamess – Feb 18, 2009

Hedging their bets — about exactly WHO owns your Mortgage?
by jamess -Sep 28, 2008

With SO much Money, chasing that VERY elusive 20-30% annual "Return on Investment" — is it any wonder that they finally found a way, to turn OUR Homes — into THEIR OWN personal Piggy Banks?

In an earlier time, we would have called it "Take the Money and Run" … today we just call it Free Markets and Creative Financing, and "Another day in the Big City".

underwater-real-estate

Too bad it’s Small Town America, that has to ALWAYS pay the Price of that very rarefied ROI … SOMEONE always has to pick up the Tab.

And Someone, always gets away, on their Yachts.

That’s just life in America, in the 21st Century — everything it seems, has its Price.
(and there’s No Shortage of Million Dollar Investors, chasing that next "big score".)