I have a soft spot for so-called “gadflies,” so I was pleased to read in the New York Times about Stanford finance professor Ms. Anat Admati who is striking fear and loathing into the hearts of those “too-big-to-fail” banks. What prompts the latter’s angst is the contention that they should increase their ratio of stockholders’ equity to loan proceeds beyond the 5 percent dictated by the famous Dodd-Frank banking reform act. “Add perhaps another zero,” says Admati.
To review the basics, banks borrow money from depositors --- those of us with savings accounts, CD’s, the float from our checking accounts, etc. and they make loans with that money. Currently, 95 percent of what banks loan out comes from what people like us have loaned them. Professor Admati’s voice in the wilderness can be heard suggesting that it is futile to be trying to tell the banks what to do with their money --- the types of loans they can make and the businesses they can be in. In one fell swoop, just demand that banks risk more of their own money rather than that of us taxpayers. Demand that, say, 30 percent of their lendable assets be comprised of stockholder’s equity (money they would raise over time by selling more stock, paying no dividends and cutting bonuses) rather than from savings accounts guaranteed by the FDIC.
Back in 2008, when our country came within twenty-four hours of having ATM machines shut down across the country, some large banks were leveraged 30 to 1, which meant that only about 3 percent of what they loaned out was their money and the rest was borrowed. All the bank’s investments and loans had to lose was 3 percent and the portion that was stockholder equity was gone. For banks like Lehman Brothers and Bear Stearns, that was exactly what happened. When it looked like Bank of America and other major banks might suffer the same fate for the same reasons, we tax-payers stepped in by funding the Troubled Asset Relief Program (TARP), but not before many in Congress argued that we should let the whole financial system go down the drain. “Welcome to the barter economy. Let’s see how that will work,” was the message from the most clueless of our elected officials.
Let’s not go there again. The banks now operate with 95 percent coming from “OPM” (Other People’s Money) and have raised their equity to 5 percent of the capital they control --- which they think is plenty. They also want to retain the right, if they get into trouble, to go through an orderly bankruptcy enjoying FDIC guarantees of depositors’ savings but that would allow them to come out at the other end with a company (and their jobs) still intact --- sort of like General Motors.
An alternative calls for the government to simply seize and close any “too-big-to-fail” bank requiring an FDIC bailout. Banks are lobbying hard against an idea that sounds great to me. It reminds me of Adrian Goldworthy who, in his book “Caesar,” pointed out that the Roman general moved vast armies on foot quickly back and forth across France by killing the soldier who came in last every day.
That analogy may be extreme, but a growing consensus holds that our legislators and financial regulators have come up largely empty some six years after the financial collapse. The fact that Professor Admati is gaining traction with a remedy as simple as the original Glass Steagall Act illustrates how nature abhors a vacuum. That former law, which separated banking from the brokerage industry, was only about twenty pages long and it did its job for over sixty years. Maybe a Bay Area “gadfly” will prove to have been our salvation when the next crisis hits.