Anat Admati and Martin Hellwig are academics with a gift for taking the mind-numbing minutiae of banking and presenting it in a way that the average reader can understand.
One by one, the self-serving protests of the banking industry against tougher regulations are lined up and struck down in “The Bankers’ New Clothes.”
You know what they are: Stringent U.S. laws will send customers fleeing to countries known for light-touch regulation. High capital requirements for banks will trigger a credit crunch. And so on.
The authors map out the regulatory flaws that make it easy for debt-junkie bankers to get rich when times are good, and leave them hanging around protesting when times are worse thanks to their own recklessness.
The system gives voice to banks and their lobbyists while the public’s interests are thinly served by a smattering of mostly underfunded citizens’ groups.
Like the toadies in the Hans Christian Anderson story “The Emperor’s New Clothes,” politicians and regulators have signed on to many of the banks’ bogus ideas.
The authors focus in particular on bankers’ frequent complaint that they can’t ramp up equity, and thus reduce risk, because equity is too expensive.
Banks -- as if we didn’t know -- prefer debt. Wouldn’t you, if the government was offering money for next to nothing and you could invest it in risky stuff that would boost returns and thus fatten your bonus check in good times?
Never mind that a bet gone sour for those same debt-crazed bankers turns out to be the taxpayers’ problem in these too-big-to-fail days.
“The public has a much greater interest in the banks’ safety than do the banks themselves,” the authors say.
Admati and Hellwig propose that 20 percent to 30 percent of banks’ total assets be in equity, substantially higher than the minimum level of 3 percent proposed in the Basel III global regulatory standard.
As for banks that can’t attract investors because they have no profits to retain, the authors are blunt: Supervisors should step in, pore over loans and other assets, and determine whether the operation is insolvent and needs to be shut down.
Sprinkled throughout the book are examples of debt and equity taken on by a fictional homebuyer named Kate. It’s a smart device to help readers from outside the banking world understand how important equity is in keeping a person -- or company -- solvent.
Kate invests $30,000 in a $300,000 home and takes on a $270,000 mortgage while her pal Paul uses the same amount of equity -- $30,000 -- to purchase a $150,000 home. If prices fall 5 percent, Paul’s $7,500 loss is only 25 percent of his investment while Kate’s is $15,000, or 50 percent.
When banks complain about the costs of equity, they leave out the inconvenient detail that bigger equity stakes are a plus when investments go down. But then again, why should they care when it’s the rest of us who clean up those messes?
In another scenario, the cagey Kate gets her rich Aunt Claire to guarantee a home purchase, which opens the opportunity for Kate to slide by with zero equity.
Now Kate is a mini-version of our government-backed banks. She has no downside -- Auntie has taken on the responsibility -- but the house is a money machine for her if home prices go up.
Admati and Hellwig have no patience with the happy talk of the U.S. Treasury and the Federal Reserve Bank about profits from the bank assets they acquired during the bailout. They say that conversation tells only part of the story, ignoring the costs of the crisis to the broader economy.
The authors want banks to bear the costs of their actions and they’re willing to admit that might mean a reduced ability of some banks to compete in global markets.
Enforce regulations and take away those implicit government guarantees, and the industry might shrink. But smaller would be better, they say.
Talent -- perhaps the physicists who run banks’ risk models -- might move to other industries. Society would be better off.
Unless you’re in the club that pockets bonuses of seven and eight figures, what’s not to like about that?
“The Bankers’ New Clothes: What’s Wrong With Banking and What To Do About It” is published by Princeton University Press (398 pages, $29.95). To buy this book in North America, click here.
(Susan Antilla is a columnist for Bloomberg News. The opinions expressed are her own.)
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