Original Proposal - Our Current House-Of-Cards National Banking System - Aug 14


Our focus will be “The Bankers New Clothes: What’s Wrong with Banking and What To Do About It” by Anat Admati and Martin Hellwig (Princeton U Press – 2/24/2013 - $22.03 from Amazon.com – 392 pages)

Ms. Anat Admati (PhD Stanford; MA, Yale; BSc, Hebrew Univ. Jerusalem) is a Professor at Stanford’s Graduate School of Business and Mr. Martin Hellwig (PhD, M.I.T., Diploma in Economics, University of Heidelberg, Germany) is an Economics Professor at the University of Bonn, Germany

The central problem at the core of “The Bankers’ New Clothes” is how thin the capital ratios are for commercial banks, say only 3% of deposits -- compared to, say, even 20% equity being considered “thin” for regular corporations and less than 20% equity being considered “sub prime” for a home mortgage. For Admati and Hellwig, the solution is obvious = increase the capital ratios required by bank regulators.

However, the basic rot which our authors will undoubtedly explain, is caused by the lack of “market discipline” when “free money” is available. In other words, our national banking system obtains “free money” (i.e., deposits at far less than the interest rates that would prevail if the actual degree of risk were taken into account) because of the guarantees of the U.S. Federal Deposit Insurance Corporation (”FDIC”). When such “free money” is invested in risky assets such as sub-prime mortgages, the result is disaster.

So why were we so surprised at the recent economic meltdown of commercial banks that invested “free money” in subprime mortgages???

After all, this was nothing more than a Grade Z re-run of the “Savings and Loan Crisis” of the 1980’s and 1990’s!!! The S&L’s had also obtained their “free money” courtesy of U.S. governmental deposit guarantees and invested the “free money” in long-term fixed-rate mortgages. When the Federal Reserve Bank had to raise interest rates in the 1980’s to combat inflation, the S&L’s were “caught with their pants down” -- having to pay the high short-term interest rates on their deposits while being stuck with the low long-term interest income on their mortgages.

The stupidity of the S&L’s in funding long-term assets with short-term borrowing was just as stupid as the commercial banks during the last decade funding sub-prime mortgages with their “free money”!!!

The U.S. Government’s Resolution Trust Corporation which was formed to salvage as much value as possible from the “toxic assets” of the failed S&L’s (to use a term that became popular with the recent meltdown of the commercial banks), was forced to shut down 747 of the nation’s 3,234 S&L’s at a total cost of $370 billion according to estimates of the U.S. General Accounting Office (“GAO”) of which $341 billion was borne by U.S. taxpayers!!! [And that was when the U.S. dollar was still worth something!!!]

Additional rot which our authors will also undoubtedly explain, was the 1999 repeal of the depression-era Glass-Steagall Act which, for 66 years, had prevented commercial banks and their “free money” from being combined with investment banks and their risky investment vehicles.

Obviously, commercial banks are still permitted to obtain “free money” courtesy of FDIC guarantees, they are still permitted to have razor-thin capital ratios (3% according to our authors when 20% for a normal corporation would be considered over-leveraged), and they are still permitted to be combined with investment banks and their risky investment vehicles.
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