Reread "The Bankers' New Clothes" - Still a fresh look at banking

 

It is 10 years since The Bankers' New Clothes was written by two of the best bank finance professors. It was supposed to explain the risks with banks and what we can do to diminish the risk to the economy and the government, taxpayers, who provide an insurance backstop.  We wrote about it in  What is it about bankers' clothes?  The argument of Admati and Hellwig its simple, banks need more capital and less leverage. Banks are not special relative to any other firm that uses leverage to boost profits. If banks make bad investments with leverage, the pain is real. We can talk about risk management and supervision but the best and first line of defense should be more equity in the business. 

Look at all the bank failures this year. The problem is the same as any in the past. More investments that turn unprofitable and blow through all the equity. The threat of losing equity makes any lender or depositor want to exit. Increase equity the downside risk is limited. Of course, greater equity will impact lending and bank decision making, that may end up being a good thing for the economy.  This does not change the original sin of zero interest rates for over decade; however, the responsibility of managing assets still rests with the bankers.