Books - The Bankers´ new clothes by Anat Admati and Martin Hellwig

What Do Banks Do?

By Arnold Kling

"For much of the nineteenth century, when banks were partnerships whose owners were fully liable for their debts, it was common for banks to have equity on the order of 40 percent or even 50 percent of their total assets. Around 1900, 20–30 percent equity for banks was common in many countries. These equity levels were not mandated by any regulation. Rather, they emerged naturally in the markets in which the banks' owners and managers, depositors, and other investors interacted. The decline that occurred subsequently in the twentieth century was closely related to governments' needs for finance in World War I and to the development and repeated extensions of the various safety nets by which governments support the banking industry, from explicit guarantees provided by deposit insurance to the bank bailouts and implicit guarantees for too-big-to-fail banks." — 

Anat Admati and Martin Hellwig, The Bankers' New Clothes, p. 178.

We need to reconsider the relationship between banks and government.

Anat Admati and Martin Hellwig raise two important issues in their new book. The first issue is whether banks need to be levered as highly as they are. Modern banks have ratios of debt to equity that often exceed 90 percent. The second issue is the unhealthy codependence of government officials and banks, and what might be done about it.

Unfortunately, I do not think that Admati and Hellwig have addressed these issues persuasively. They rely too much on what might be termed “verbal leverage,” meaning that I found the ratio of rhetoric to evidence in their book to be too high for my taste.

I will discuss the issue of bank leverage in this essay. In a subsequent essay, I will discuss government-bank codependency.

Why Do Firms Issue Debt? ....

How Banks Transform Debt ....

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