Marshall Auerback Interviews Anat Admati
Econintersect: Marshall Auerback, Director of Institutional Partnerships at the Institute for New Economic Thinking, recently interviewed Anat Admati, George G.C. Parker Professor of Finance and Economics, Graduate School of Business at Stanford University. The topic was the remaining economic dangers connected with the banking system.
The discussion focused on how recent banking events relate to the issues covered in Prof. Admati’s book, The Bankers’ New Clothes: Whats Wrong with Banking and What to Do about It, co-authored with Martin Hellwig, Max Planck Institute.
Here is three minute summary of her book presented by Prof. Admati:
Auerback asks, in the text accompanying the video:
Why does the financial system remain so reckless?
His answer starts with:
The answer lies in what can be called “the political economy of flawed claims,” a toxic combination of entrenched, self-serving banking myths and the politics of banking. As a result, key issues are greatly misunderstood, and essential regulations to counter the harmful forces at play have not been put into place.
Auerback’s amplification and extension of these arguments can be read at the Institute for New Economic Thinking website.
Lambert Strether at Naked Capitalism has pointed us to a paper by Admati and Hellwig (Lambert reviewed that paper) in which they rebut critical comments they have received on their book. The title of the paper is “The Parade of the Bankers’ New Clothes Continues: 23 Flawed Claims Debunked“.
What are the 23 flawed claims? Admati present the list in language so simple that no one should have any difficulty in understanding each item:
Claim 1: Capital is money that banks hold or set aside as a reserve, like a rainy day fund.
Claim 2: Requiring banks to hold reserves equal to 15% of their assets does not make them safe. Therefore, a capital requirement of 15% is useless.
Claim 3: The argument for requiring banks to have substantially more equity is only based on the so-called Modigliani-Miller theorem, which does not apply in the real world because its assumptions are unrealistic.
Claim 4: The key insights from corporate finance about the economics of funding, including those of Modigliani and Miller, are not relevant for banks because banks are different from other companies.
Claim 5: Banks are special because they produce (or create) money.
Claim 6: Increasing equity requirements would reduce the ability of banks to provide people with deposits and other short-term claims that are liquid and can be used like money.
Claim 7: Increasing equity requirements is undesirable because the funding costs of banks would increase.
Claim 8: Increased equity requirements would lower the banks’ return on equity (ROE) and therefore harm shareholders and make investors unwilling to invest in banks’ stocks.
Claim 9: Increased equity requirements would force banks to make fewer loans.
Claim 10: Increased equity requirements would induce banks to lend less, and this would be harmful for the economy.
Claim 11: Higher equity requirements are undesirable because they would prevent banks from taking advantage of government subsidies and would force them to charge higher interest on loans.
Claim 12: Banks cannot raise equity and will have to shrink if equity requirements are increased; this will be bad for the economy.
Claim 13: Increasing equity requirements would harm economic growth.
Claim 14: Basel III is already tough, doubling or tripling previous requirements. Banks have much more capital [equity] now than they had earlier and they are safe enough.
Claim 15: Basel III is based on careful scientific analysis of the cost and benefits of different levels of capital requirements, whereas the rough numbers of those who advocate much higher requirements cannot guide policy because they are not supported by scientific calibration.
Claim 16: Because capital requirements should be adjusted to risk, it is essential to rely primarily on requirements that are based on assigning risk weights to assets.
Claim 17: Instead of issuing more equity, banks should be required to issue long-term debt or debt that converts to equity when a trigger is hit, so-called “contingent capital” or co-cos.
Claim 18: The Dodd-Frank Act in the US has done away with the need to bail out banks; if a bank gets into trouble, the FDIC will be able to resolve it without cost to the taxpayer.
Claim 19: If capital requirements are increased, banks will increase their “risk appetite,” which may make the system more dangerous.
Claim 20: If capital requirements are increased, bank managers will be less disciplined.
Claim 21: Tighter regulation is undesirable because it would cause activities to move to the unregulated shadow banking system.
Claim 22: Since banking is a global business, banking regulation must be coordinated and harmonized between regulators worldwide. It is important to maintain a “level playing field” in global competition.
Claim 23: Stricter regulation is would harm “our” banks; instead we should be supporting them in global competition.
The debunking by Admati and Hellwig is similarly straightforward. Read their paper.
Also worthwhile are Lambert Streither’s comments at Naked Capitalism. He suggests that the use of the word “flawed” by Admati and Hellwig is too polite. The correct term? False.
