Why do banks and protective regulators howl so loudly at these simple suggestions? As Ms. Admati and Mr. Hellwig detail in their chapter “Sweet Subsidies,” it’s because bank debt is highly subsidized, and leverage increases the value of the subsidies to management and shareholders. To borrow without the government guarantees and expected bailouts, a bank with 3% capital would have to offer very high interest rates— rates that would make equity look cheap. Equity is expensive to banks only because it dilutes the subsidies they get from the government. That’s exactly why increasing bank equity would be cheap for taxpayers and the economy, to say nothing of removing the costs of occasional crises.
John Cochrane reviews The Bankers’ New Clothes By Anat Admati and Martin Hellwig Princeton, 398 pages, $29.95
(…) the clear, central argument of “The Bankers’ New Clothes”: More capital and less debt, especially short-term debt, equals fewer crises, and common contrary arguments are nonsense. More capital would be far more effective at preventing crises than the tens of thousands of pages of Dodd-Frank regulations and its army of regulators, burrowed deep in the financial system, on a hopeless quest to keep highly leveraged and subsidized too-big-to-fail banks from taking too much risk. Once the rest of us accept this central idea, the details fill in naturally.
How much capital should banks issue? Enough so that it doesn’t matter! Enough so that we never, ever hear again the cry that “banks need to be recapitalized” (at taxpayer expense)!
Do read John’s long, thoughtful review. Then do what we just did, buy the Kindle edition for yourself, and gift one to your congress-person or MP. I’m not sure politicians can read, but if they read and understand this book, there is a very small chance of change. However politicians won’t touch this issue unless there is a surefire way to get re-elected, including replacing all the campaign funds they get from the financial lobby.