What is it about bankers' clothes?

Admati and Hellwig provide a simple; nevertheless, insightful book on banks and banking problems. Banks do not have clothes different from other firms. They should not be treated as special. Rather they should be put to the test of any corporation that has to look at financing options between equity and debt. Can they give a good return on equity relative to the risks taken? Too much debt and a firm is over levered and at significant risk of failure. There is not nothing special about these risks for banks except that bankers, regulators, and politicians make them special. The specialness of banks is not associated with the firm, but with the banking industry and how bank risks can have negative externalities. These externalities can be controlled.

Their argument is very straightforward and well-developed through the simple analogy of home ownership. If you have too little equity when you borrow to buy an asset, you will have too much risk. The return is great when you sell if the house increases in value but if the price of the home decreases, the equity can be destroyed very quickly.  If the equity capital is less than 10% of the assets, the risk of failure is huge. If these risk turns negative, the government, that is the taxpayers, will foot the bill if there is some form of bail-out. Banks take risk and pocket the upside and stiff the taxpayer with the downside. 

The solution is also very straightforward, require banks to hold more equity. Banks will say that the price of raising equity is high and that it will cause a reduction in lending, but the authors present strong arguments that this is not case, Equity can easily be raised through halting stock buybacks and cutting dividends. 

Forget all the extra regulation for banks. We can make this issue much simpler by just focusing on the equity level. The global financial community has done an effective job of stopping the movement for higher capital and equity bases. This is unfortunate, but clearly written books like this will get us to a better place faster than more regulation.