The Bankers' New Clothes: What's Wrong with Banking and What to Do about It

By Anat Admati; Martin Hellwig | Go to book overview

FIVE
Banking Dominos

It was incredible. In exchange for a few million bucks, this insurance company
was taking the very real risk that $20 billion would simply go poof.

Michael Lewis, The Big Short, regarding American International Group (AIG)

THE GLOBAL FINANCIAL CRISIS that broke into the open in the summer of 2007 is often ascribed to excessive mortgage lending and excessive securitization of low-quality, subprime mortgages in the United States.1 At the peak of the crisis, in October 2008, the IMF estimated that the total losses of financial institutions from subprime-mortgage-related securities amounted to $500 billion.2

When seen by itself, $500 billion seems huge, but in the context of a global financial system in which the banking sector’s assets are on the order of $80 trillion or more, it is actually not all that large. In fact, the $500 billion loss from subprime-mortgage-related securities is dwarfed by the more than $5 trillion of losses in the value of shares on U.S. stock markets in the early 2000s, when the so-called technology bubble of the late 1990s burst.3

How could this loss in the value of mortgage-related securities have such a large effect on the global financial system and on the broader economy? Why was the subprime crisis so much more damaging than the bursting of the technology bubble a few years earlier? And why has this crisis been so much more damaging to the world economy than the many banking crises of the early 1990s, including the Japanese crisis, which also involved very large losses in real estate lending?4

The one-word answer to these questions is “Contagion.” In 2007, U.S. subprime-mortgage-related securities were mainly held by banks and their affiliates. These banks were very highly indebted, particularly with short-term

-60-

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The Bankers' New Clothes: What's Wrong with Banking and What to Do about It
Table of contents

Table of contents

  • Title Page iii
  • Contents vii
  • Preface to the Paperback Edition ix
  • Preface xiii
  • Acknowledgments xvii
  • One - The Emperors of Banking Have No Clothes 1
  • Part One - Borrowing, Banking, and Risk 15
  • Two - How Borrowing Magnifies Risk 17
  • Three - The Dark Side of Borrowing 32
  • Four - Is It Really "A Wonderful Life"? 46
  • Five - Banking Dominos 60
  • Part Two - The Case for More Bank Equity 79
  • Six - What Can Be Done? 81
  • Seven - Is Equity Expensive? 100
  • Eight - Paid to Gamble 115
  • Nine - Sweet Subsidies 129
  • Ten - Must Banks Borrow So Much? 148
  • Part Three - Moving Forward 167
  • Eleven - If Not Now, When? 169
  • Twelve - The Politics of Banking 192
  • Thirteen - Other People’s Money 208
  • Notes 229
  • References 337
  • Index 363
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