By Moe Bedard

There are over 8,000 US Banks insured by the FDIC operating across the country and the reports coming from these banks are actually good. Most of the 8,000 banking institutions are doing fine because they do not have huge problems with toxic mortgage portfolios. Nor do they have loan portfolios full of cancerous pay option mortgages.

The sector that is dying and is being bailed out with $700 billion of yours and my money is called “The Shadow Banking System.”  Wikipedia - The “shadow banking system” or the “shadow financial system” is largely formed by non-bank financial institutions that like banks, borrow short and in liquid forms and lend or invest long in more illiquid assets. The shadow system whose members are broker-dealers, hedge funds, private equity groups, structured investment vehicles and conduits, money market funds and non-bank mortgage lenders.

What we have seen on Wall Street is a run on the shadow banking system that is leading to its eventual demise and due to that fact that most all our country’s money is somehow tied to toxic investments; these institutions will have to be regulated like banks, to avoid moral hazard and quite possibly a worldwide financial break down.

Before, these “so-called banks” wanted to operate in the lending and investment shadows with no or little regulation. But now since the ponzi scheme has been unraveled, they are asking for help and to be regulated and protected by our government. AKA Bailed out!

Now these shadow bankers are requesting a status change from independent broker dealer to bank holding company. Soon thereafter, Merrill Lynch merged with Lehman Bros and Goldman and Morgan Stanley converted to commercial banks after Lehman went under and was snatched up by Bank of America.

Most all remaining shadow/pyramid players are looking to merge with a commercial bank with a stable deposit base and permanent access to the Federal Reserve’s cash window. Of course this severe financial crisis is also taking its toll on a lot of traditional banks: hundreds are insolvent and will have to close.

Over the last the last two decades alone our country has witnessed huge man-made pyramid schemes involving savings and loans institutions of the late 1980 and the dot.coms of the late 19990′. Now we have the mortgage and housing crisis/ pyramid scheme constructed by none other, than “The Shadow Banking System.”

Here is what Bill Gross, Managing Director of PIMCO had to say about a secret banking system gone wild.

Our modern shadow banking system craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever.

According to the Bank for International Settlements (BIS), CDS totaling $43 trillion were outstanding at year end 2007, more than half the size of the entire asset base of the global banking system. Total derivatives amount to over $500 trillion, many of them finding their way onto the balance sheets of SIVs, CDOs and other conduits of their ilk comprising the Frankensteinian levered body of shadow banks.

Pyramid schemes and chain letters collapse because there is no more credit to feed them. As the system of modern day levered shadow finance slows to a crawl, or even contracts at the edges, its ability to systemically fertilize economic growth must be called into question.