Newspaper article St Louis Post-Dispatch (MO)

Banks Aren't Too Big to Regulate, Authors Say

Newspaper article St Louis Post-Dispatch (MO)

Banks Aren't Too Big to Regulate, Authors Say

Article excerpt

Three truths about banking that I learned when I ran the Post- Dispatch business news department more than 30 years ago came back to me while reading "The Bankers' New Clothes," a clearly written, sensible analysis of problems and cures for the U.S. banking system.

Truth No. 1: Banking is a 3-6-3 business or at least it used to be.

When the financial world was a much less complex place, bankers were said to have a very simple job: They attracted deposits that earned 3 percent, turned around and lent that money out to others at 6 percent and were on the golf course by 3 p.m.

Then, the once-staid industry became more complicated and less regulated, and bankers used that freedom to help themselves but ultimately hurt society at large, Anat Admati and Martin Hellwig argue.

To make their point, they use the analogy of Hans Christian Andersen's tale of the emperor who claims to have the most exquisite outfit ever made a boast that his frightened underlings agree with until a little child shouts out that he really is wearing no clothes at all.

Admati, a finance professor at Stanford, and Hellwig, director of the Max Planck Institute in Germany, say "The Bankers' New Clothes" are claims of privilege and complexity that bankers often use to fend off new rules designed to curb their activities.

The authors' main point is that the rules need to be changed so that banks, instead of being highly leveraged through borrowing, would need a more solid foundation of equity to help them weather tough times and to curb their desire to devise and invest in increasingly intricate and risky financial instruments.

Admati and Hellwig take a lot of time to clearly explain the problems with depending too much on borrowed money, which brings us to the second saying that explains why banking can be precarious.

Truth No. 2: If you owe someone $50,000 and can't pay, you're in trouble. If you owe someone $50 million and can't pay, they're in trouble.

To illustrate the benefits and the perils of debt, the authors do a pretty good job of keeping things simple. The example they return to again and again is Kate, a homeowner who, depending on how much money she must borrow to buy a $300,000 house, can either be sitting pretty or just a step away from ruin. …

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