Our Current House-Of-Termites National Banking System


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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Our Current House-Of-Termites National Banking System

Post by UtahOwl »

Originally proposed by UtahOwl - Fri May 03, 2013 3:44 pm – 10 views before being transplanted here.

I propose that we read "The Bankers New Clothes: What’s Wrong with Banking and What To Do About It" by Anat Admati & Martin Hellwig. It looks at the problems with today’s banking system, examining and refuting the arguments used to justify the lack of reform after the recent financial crises, and suggesting things that may be done to prevent future crises. It is available from Amazon for $17.46 HB or $9.88 Kindle Ed. Below are excerpts from 3 reviews:

John Cochrane, Wall Street Journal
http://online.wsj.com/article/SB1000142 ... 89202.html:

The central problem, at the core of Anat Admati and Martin Hellwig's "The Bankers' New Clothes," is capital. In order to make $100 of loans, a typical bank borrows $97—from depositors, from money-market funds, from other banks, or from bondholders—and sells $3 of stock, its "capital." So if only 4% of the bank's loans fail, the shareholders are wiped out, and the bank cannot pay its debts. Worse, if there is a rumor that some loans are in trouble, creditors may "run," each trying to get his money out first, and force a needless bankruptcy. Think of Jimmy Stewart in "It's a Wonderful Life."

When banks are on the brink, all sorts of other pathologies emerge. Bankers and their regulators may try to keep zombie loans on the books, hoping things will turn around. Or bankers may bet the farm on very risky loans that either save the bank or impose larger losses on creditors and the government. Ms. Admati and Mr. Hellwig explain all this nicely in their first few chapters.

The solution seems pretty obvious, no? Banks should fund their investments by selling a heck of a lot more stock and borrowing a heck of a lot less, especially in the form of run-prone short-term debt, as most other companies do.

M.C.K., The Economist
http://www.economist.com/blogs/freeexch ... quirements:

MOST of what we call money is actually short-term debt created by banks when they make loans. This means that banks are the stewards of our savings and manage the payments system. As a result, they have a privileged place in our society: governments never deliberately choose to liquidate the banking system. It always appears preferable, in the short term at least, to preserve the incumbent institutions and personnel through bail-outs. (Lending to “solvent but illiquid” firms at below-market rates is another kind of bail-out, even if it is not always called one by the authorities.)

Bankers thus have every incentive to become as “systemic” as possible and to take as much as risk as possible—they know that they can almost always get these bail-outs when they need them. Moreover, the liability of the big risk-takers (i.e., the mid-level traders rather than the executives) is often quite limited.* They keep all of the upside when times are good and leave the rest of society with the tab when their bets go south. The Bank of England’s Andrew Haldane has argued that, if you properly count the cost of crises and hidden subsidies, banking as currently practised may not actually add any value.

Policymakers have been trying to wrestle with these problems for more than a century, most recently with the Basel accords and America’s Dodd-Frank law. But, according to The Bankers’ New Clothes, a powerful new book by Anat Admati and Martin Hellwig, these reform efforts failed to address the basic problem of the crisis: banks are too fragile. The authors persuasively argue that the solution is higher levels of equity capital throughout the banking industry to offset the impact of the implied government protections against failure.

Roger B Myerson, U. Chicago
http://home.uchicago.edu/~rmyerson/rese ... wcloth.pdf:

A book worth comparing to Keynes's General Theory We expected that the Great Recession after 2007 would yield a major written response
that should be worthy of such global attention as John Maynard Keynes's General Theory received in 1936. Now we have such a book, and it is The Bankers' New Clothes: What's Wrong with Banking and What to Do About It, by Anat Admati and Martin Hellwig.

Fortunately, Admati and Hellwig have not made any attempt to define a new general theory of economics, although they are among the leading masters of theory in finance and economics today....I am a theorist, and I would certainly appreciate a broad theoretical breakthrough in economic analysis as much as anyone. But let me make a simple theoretical argument to explain why a clear and well-focused popular book may be more important for economic policy today that a deep pile of technical papers and reports. Banks are vital financial institutions that channel millions of people's savings into credit for economic investments. Banks need public regulation because they are routinely subject to temptations to abuse the trust of their many small depositors, and because none of these depositors wants to do the necessary work of monitoring to certify that the banks are trustworthy. But the vast wealth involved in the banking business is more than enough to potentially corrupt any small group of officials, and so the reliability of any regulatory system must depend on broad public monitoring of the regulatory process itself. Regulators' rulings must be based on public information according to principles that informed citizens can understand, so that public officials can be held accountable for any failure to regulate appropriately, even when a major crash does not result from this failure. Thus, any meaningful financial regulatory reform must include a clear explanation of its principles to millions of informed citizens and investors.

Admati and Hellwig's new book can fill that essential role.

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