In “The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It,” authors Anat Admati and Martin Hellwig criticize bankers such as Jamie Dimon, above, CEO of J.P. Morgan Chase & Co.
The House Financial Services Committee momentarily wondered whether to put Jamie Dimon, the financial demigod whose responsibility includes running J.P. Morgan Chase & Co., under oath when he appeared in June 2012 to explain how a trader known as the London Whale lost a few billion dollars. The committee’s chairman at the time, Rep. Spencer Bachus, an Alabama Republican, made the idea of sworn testimony disappear faster than a triple-A rating on a mortgage-backed security.
Connoisseurs of banking and financial crises may think a sworn oath is their best chance of getting credible explanations from bankers who consider honesty akin to a synthetic derivative. It’s based on something, and that’s as much as they’re willing to say in public.
“The jargon of bankers and banking experts is deliberately impenetrable,” write Anat Admati and Martin Hellwig in “The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It,” their contribution to the rich literature of bad banking and its consequences. “This impenetrability helps them confuse policymakers and the public, and it muddles the debate.”
Admati and Hellwig don’t just criticize bankers. The real strength of their book is that they walk their readers through the balance sheet and to a regulatory answer to the banking problem, an answer that’s elegant in its simplicity and far-reaching in its potential to prevent and manage financial crises. They say banks should be required to have more equity on the balance sheet. Much, much, much more equity. The authors propose 20 percent to 30 percent of total assets.
At a stroke, they would put much risk back in the private sector, the place everybody says it belongs and where few believe it is. “At such levels of equity, most banks would usually be able to cope on their own and require no more than occasional liquidity support,” Admati and Hellwig write.
Most companies manage equity levels at or above 20 percent to 30 percent of assets. Their creditors probably insist on it. Even bank balance sheets once had equity worth about 50 percent of assets. Equity means somebody else absorbs losses before the lenders take the hit, or, in the case of banks, before the government bails them out. Apple Inc., a company that has received much recognition for its success, stumbles along with no debt at all, a point Admati and Hellwig point out with relish.
Modern bankers manage a balance sheet nirvana denied to ordinary corporate mortals. The banks are like homeowners during the housing bubble. They borrow to the hilt.
As Admati and Hellwig show, using a simple mortgage to illustrate, the bankers have figured out that using somebody else’s money to pay for almost all their assets gives them a nice profit when asset prices go up and gives somebody else — often taxpayers — a painful loss when they go down.
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