Anat Admati is the George G.C. Parker Professor of Finance and Economics at the Graduate School of Business, Stanford University. Here she is interviewed by Marshall Auerback, the Institute for New Economic Thinking’s Director of Institutional Parternships.
Lambert here: Since it’s the weekend and nobody’s watching, I’ll dip my toe in the waters of finance; maybe at some future point I’ll actually wade into the shallow end of the pool! This interview contains an interesting, nuts and bolts discussion of the Cyprus and London Whale debacles, and it’s worth a listen to see how a finance professional recapitulates them; I found it interesting that Admati uses the phrase “political economy” unapologetically.
Both Auerback and Admati agree that we seem not to learn from past crises. The interview concludes:
AUERBACH: What sort of new economic thinking do you personally think we should be doing to be consistent with our mandate?
ADMATI: Well, I think the economic thinking is partly [an issue of] how the political economy of the regulation, how to make certain regulations work, in an environment where there’s a combination of self-interest and confusion. So the issue is not necessarily in this case some of the new economic thinking is really kind of back to basics type of thinking, and not getting confused by narratives that are actually flawed, and then sort of taking it to the policy context, how to make it the economics and the political economy work.
I would ask “work for whom?” since assuredly our current arrangements work for some, but never mind that. Because Jeebus, since I’m new to this stuff, can it really be true that the idea pf environments marked by “a combination of self-interest and confusion” isn’t already a basic working assumption in the discipline of economics? (Especially since we see, in accounting control fraud, which played such a role in creating the great financial crisis, that actors create confusion deliberately, out of self-interest.) Isn’t the real world just like that?
Anyhow, the material Admati supplies along with the interview is really interesting, and much more tool focused than the interview. I fixed on the phrase “flawed claims” — I’m a magpie for glittering phrases — because I thought Admati meant financial claims, like debts, which, being false, would have to be unravelled sooner or later, taking down the whole system, destruction, collapse, Götterdämmerung, SHTF, etc.
But no! Admati means claims as a rhetorician would understand the word: An assertion that something is or should be true, like “It is the case that Jamie Dimon is a lying weasel, albeit charismatic in his own way,” or “Poor people must be punished.” And that led me to this paper, “The Parade of the Bankers’ New Clothes Continues: 23 Flawed Claims Debunked,” by Admati and Martin F. Hellwig of the Max Planck Institute for Research on Collective Goods (!). The authors seem to have aggregated false claims made as feedback to their book, and reinserted, as it were, the system’s outputs back into the system itself, in the form of a paper. Here’s the PDF of the paper, and here are the 23 claims. I know 23 is rather a lot, but you’ve probably heard a shouting head on the TV emit all of them, at one time or another.
List of Flawed Claims
Claim 1: Capital is money that banks hold or set aside as a reserve, like a rainy day fund.
Claim 2: Requiring banks to hold reserves equal to 15% of their assets does not make them safe. Therefore, a capital requirement of 15% is useless.
Claim 3: The argument for requiring banks to have substantially more equity is only based on the so-called Modigliani-Miller theorem, which does not apply in the real world because its assumptions are unrealistic.
Claim 4: The key insights from corporate finance about the economics of funding, including those of Modigliani and Miller, are not relevant for banks because banks are different from other companies.
Claim 5: Banks are special because they produce (or create) money.
Claim 6: Increasing equity requirements would reduce the ability of banks to provide people with deposits and other short-term claims that are liquid and can be used like money.
Claim 7: Increasing equity requirements is undesirable because the funding costs of banks would increase.
Claim 8 : Increased equity requirements would lower the banks’ return on equity (ROE) and therefore harm shareholders and make inve stors unwilling to invest in banks’ stocks.
Claim 9: Increased equity requirements would force banks to make fewer loans.
Claim 10: Increased equity requirements would induce banks to lend less, and this would be harmful for the economy.
Claim 11: Higher equity requirements are undesirable because they would prevent banks from taking advantage of government subsidies and would force them to charge higher interest on loans.
Claim 12: Banks cannot raise equity and will have to shrink if equity requirements are increased; this will be bad for the economy.
Claim 13: Increasing equity requirements would harm economic growth.
Claim 14: Basel III is already tough, doubling or tripling previous requirements. Banks have much more capital [equity] now than they had earlier and they are safe enough.
Claim 15: Basel III is based on careful scientific analysis of the cost and benefits of different levels of capital requirements, whereas the rough numbers of those who advocate much higher requirements cannot guide policy because they are not supported by scientific calibration.
Claim 16: Because capital requirements should be adjusted to risk, it is essential to rely primarily on requirements that are based on assigning risk weights to assets.
Claim 17: Instead of issuing more equity, banks should be required to issue long-term debt or debt that converts to equity when a trigger is hit, so-called “contingent capital” or co-cos.
Claim 18: The Dodd-Frank Act in the US has done away with the need to bail out banks; if a bank gets into trouble, the FDIC will be able to resolve it without cost to the taxpayer
Claim 19: If capital requirements are increased, banks will increase their “risk appetite,” which may make the system more dangerous.
Claim 20: If capital requirements are increased, bank managers will be less disciplined.
Claim 21: Tighter regulation is undesirable because it would cause activities to move to the unregulated shadow banking system.
Claim 22 : Since banking is a global business, banking regulation must be coordinated and harmonized between regulators worldwide. It is important to maintain a “level playing field” in global competition.
Claim 23 : Stricter regulation is would harm “our” banks; instead we should be supporting them in global competition.
One and all false!
I’m a sucker for numbered lists — “23 Weird Claims Banksters Make” — because they’re easy to refer to, and to chain together. We can claim, for example, that if Claim 18 is false, as Admati claims it is, then when the next — inevitable! — financial crisis comes along, we are so hosed. (For some definition of “we,” of course; the lesson of the 2008 crash and the subsequent and continuing depression, is that “this is working out well for them”, where “them” is some “us” unlikely to be us.)
Let’s look at one debunking in detail: Claim 22. (I picked this one because it sounds like the sort of claim that TPP advocates would make:
Flawed Claim 22: Since banking is a global business, banking regulation must be coordinated and harmonized between regulators worldwide. It is important to maintain a “level playing field” in global competition.
What’s wrong with this claim? The claim, discussed in Chapter 12, is false. If some countries foolishly allow their banks to pursue very risky strategies and to borrow excessively, this is not a reason why other countries should do the same. Each country should be concerned with how much of a risk from its banks it is willing to accept, just as each country has its own building codes, consumer safety standards, environmental regulation and energy policy. We would not allow chemical companies to pollute rivers and lakes simply because the industry maintains that somewhere in the world another country is allowing these things. The search for “level playing fields” in global competition is highly damaging if it leads to a race to the bottom, where each country ends up fighting stricter regulation on behalf of its members of the industry.
The claim is interesting, because it’s a policy claim that “must” be true. Admati’s responses are No, things don’t have to be this way. But who is deciding the “must”? Let me highlight one sentence in her debunking.
We would not allow chemical companies to pollute rivers and lakes simply because the industry maintains that somewhere in the world another country is allowing these things.
Well, if you’re drafting the TPP, or supporting it, that’s exactly what “we” “would” allow. Friends of the Earth:
To avoid the most serious environmental harms, the TPP negotiators must [ha] address the following issues, among others:
- Reject the proposed TPP investment chapter that would authorize foreign investors to bypass domestic courts and bring suit before special international tribunals biased in favor of multinationals. Foreign investors could seek awards of money damages, of unlimited size, in compensation for the cost of complying with environmental and other public interest regulations. They could even seek compensation for lost future profits.
If the international tribunals are biased toward investors, then indeed “we” will have had exactly the kind of race to the bottom that Admati so justly decries and, history being written by the winners, “should” have had it, too. Because the free market!
So, and most definitely FWIW, I think Admati’s done the world a great service by aggregating the “flawed” — I keep writing “false” — claims of banksters and their apologists and shills. It’s great to have all the lies gathered in one place and debunked.
However — and here is where the obvious riposte is “Read my book!” OK! OK! — when speaking of political economy, conflict goes down to the bone, down to very simple, one syllable words like “we,” “work,” “must,” and “should,” which turn out to be highly contested. Because TINA?