The Bankers’ New Clothes | Anat Admati

Summary of: The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It – Updated Edition
By: Anat Admati


Discover the truths behind the banking industry’s resistance to reform in the aftermath of the 2008 financial crisis. ‘The Bankers’ New Clothes’ by Anat Admati exposes the dangerous practices of big banks, such as their reliance on debt for financing and their opposition to stricter regulations. Get ready to debunk popular myths that banks propagate in order to maintain the status quo and uncover how their risky actions endanger the economy. In this summary, you will learn about the unique characteristics of banking as compared to other industries, the origins of banks’ dependence on debt, and the solutions that can improve the safety and stability of our financial system.

The Banking Industry and Financial Reform

Bankers against Serious Reform of Taxpayer-Rescued Financial Industry

Since the 2008 financial panic, the banking industry has been lobbying against substantial reform of the taxpayer-rescued financial industry. Bankers believe that the crisis was a fluke and attribute it to a one-off occurrence. They reject stricter regulations, claiming it can impede economic growth, and increased consumer cost. Bankers warn to reduce lending if Congress imposes longer borrowing rules or enforces more capital to be borrowed. They predict complete economic ruin if regulators implement measures to maintain financial stability. Bank executives think that banking differs from every other industry because it finances over 90% of its assets through debt. Banks avoid the expensive equity market and rely on cheaper debt, which is easier because creditors know that large financial institutions seen as too big to fail will receive government rescue assistance during difficult times. Taxpayers pay the bill with destabilizing bailouts, whereas society does not subsidize polluters to damage the environment. Large banks take risks that everyone pays while they alone profit from it. The banking industry needs political will to reform the current system for the economy to work better.

The Risk of Debt

Debt provides immense leverage, but it also magnifies risk, leaving borrowers vulnerable to increased losses if investments fail. Companies often combine debt and equity to fund growth and are cautious about their investment decisions. However, banks, which deal with money and power, often rely on debt with equity levels as low as 6%-8%, a practice not applicable to most individuals or corporations. Such overhanging debt in times of crises can make them excessively cautious or reckless, leading to bankruptcy eventually.

The intricate world of banking

Banks play a critical role in the economy, executing payments, mediating the flow of funds, assessing risk, and lending money to businesses. However, their core practices pose great risks, particularly the concept of maturity transformation, which involves funding long-term investments like loans with short-term debts like deposits. Bank runs are a common issue, and while deposit insurance helps to mitigate them, bad loan decisions, risky endeavors, and untested financial innovations also lead to problems. The 2007-2009 global crisis is a testament to the risks involved, with the failure of large banks creating a ripple effect across the world. Government bailouts propping up weak banks also pose significant challenges, with taxpayer resources drained and economic capacity strained. For the banking system to become safer and sounder, it is crucial for banks to use less debt and more equity.

The True Cost of Weak Banks

Banks warn that regulatory reforms would increase their costs, which consumers would have to pay. However, the hidden expense of maintaining weak, indebted banks whose instability threatens all of society costs much more. The dissonance between what bankers say and what their businesses convey is striking. For example, JPMorgan Chase CEO Jamie Dimon refers to his firm’s “fortress balance sheet.” But its off-balance-sheet commitments total almost $1 trillion. Banks like JPMorgan Chase are much bigger than they were pre-2008 crisis, but they are no less fragile. Bank size also raises questions about costs and vulnerability. Institutions with more than $100 billion in assets may be less efficient, less manageable, and less governable than smaller banks. Clearly, large banks cost society more because of the implicit too-big-to-fail government guarantee.

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