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<a href="http://www.nytimes.com/"><img src="http://graphics8.nytimes.com/images/misc/nytlogo153x23.gif" alt="The New York Times" align="left" border="0" hspace="0" vspace="0"></a>
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<div class="">August 25, 2013</div>
<h1>We’re All Still Hostages to the Big Banks</h1>
<h6 class="">By
<span><span>ANAT R. ADMATI</span></span></h6>
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<p>
STANFORD, Calif. — NEARLY five years after the bankruptcy of Lehman
Brothers touched off a global financial crisis, we are no safer. Huge,
complex and opaque banks continue to take enormous risks that endanger
the economy. From <a href="http://www.nytimes.com/2013/07/14/business/bankers-are-balking-at-a-proposed-rule-on-capital.html">Washington</a> to <a href="http://www.nytimes.com/2013/08/10/business/global/in-germany-little-appetite-to-change-troubled-banking-system.html">Berlin</a>,
banking lobbyists have blocked essential reforms at every turn. Their
efforts at obfuscation and influence-buying are no surprise. What’s
shameful is how easily our leaders have caved in, and how quickly the
lessons of the crisis have been forgotten. </p>
<p>
We will never have a safe and healthy global financial system until
banks are forced to rely much more on money from their owners and
shareholders to finance their loans and investments. Forget all the
jargon, and just focus on this simple rule. </p>
<p>
Mindful, perhaps, of the coming five-year anniversary, regulators have
recently taken some actions along these lines. In June, a committee of
global banking regulators based in Basel, Switzerland, <a href="http://dealbook.nytimes.com/2013/06/26/proposed-guidelines-could-require-banks-to-raise-billions-in-capital/">proposed</a>
changes to how banks calculate their leverage ratios, a measure of how
much borrowed money they can use to conduct their business. </p>
<p>
Last month, federal regulators <a href="http://www.nytimes.com/2013/07/12/business/economy/big-banks-grumbling-about-planned-capital-rules.html">proposed</a>
going somewhat beyond the internationally agreed minimum known as Basel
III, which is being phased in. Last Monday, President Obama <a href="http://www.nytimes.com/2013/08/20/business/obama-presses-for-action-on-bank-rules.html">scolded regulators</a>
for dragging their feet on implementing Dodd-Frank, the gargantuan 2010
law that was supposed to prevent another crisis but in fact punted on
most of the tough decisions. </p>
<p>
Don’t let the flurry of activity confuse you. The regulations being proposed offer little to celebrate. </p>
<p>
>From Wall Street to the City of London comes the same wailing: requiring
banks to rely less on borrowing will hurt their ability to lend to
companies and individuals. These bankers falsely imply that capital
(unborrowed money) is idle cash set aside in a vault. In fact, they want
to keep placing new bets at the poker table — while putting taxpayers
at risk. </p>
<p>
When we deposit money in a bank, we are making a loan. JPMorgan Chase,
America’s largest bank, had $2.4 trillion in assets as of June 30, and
debts of $2.2 trillion: $1.2 trillion in deposits and $1 trillion in
other debt (owed to money market funds, other banks, bondholders and the
like). It was notable for surviving the crisis, but no bank that is so
heavily indebted can be considered truly safe. </p>
<p>
The six largest American banks — the others are Bank of America,
Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley — collectively
owe about $8.7 trillion. Only a fraction of this is used to make loans.
JPMorgan Chase used some excess deposits to trade complex derivatives in
London — losing more than $6 billion last year in a <a href="http://www.nytimes.com/2012/10/07/magazine/ina-drew-jamie-dimon-jpmorgan-chase.html">notoriously bad bet</a>. </p>
<p>
Risk, taken properly, is essential for innovation and growth. But
outside of banking, healthy corporations rarely carry debts totaling
more than 70 percent of their assets. Many thriving corporations borrow
very little. </p>
<p>
Banks, by contrast, routinely have liabilities in excess of 90 percent
of their assets. JPMorgan Chase’s $2.2 trillion in debt represented some
91 percent of its $2.4 trillion in assets. (Under accounting
conventions used in Europe, the figure would be around 94 percent.)
</p>
<p>
Basel III would permit banks to borrow up to 97 percent of their assets.
The proposed regulations in the United States — which Wall Street is <a href="http://www.nytimes.com/2013/07/14/business/bankers-are-balking-at-a-proposed-rule-on-capital.html">fighting</a>
— would still allow even the largest bank holding companies to borrow
up to 95 percent (though how to measure bank assets is often a matter of
debate). </p>
<p>
If equity (the bank’s own money) is only 5 percent of assets, even a
tiny loss of 2 percent of its assets could prompt, in essence, a run on
the bank. Creditors may refuse to renew their loans, causing the bank to
stop lending or to sell assets in a hurry. If too many banks are
distressed at once, a systemic crisis results. </p>
<p>
Prudent banks would not lend to borrowers like themselves unless the
risks were borne by someone else. But insured depositors, and creditors
who expect to be paid by authorities if not by the bank, agree to lend
to banks at attractive terms, allowing them to enjoy the upside of risks
while others — you, the taxpayer — share the downside. </p>
<p>
Implicit guarantees of government support perversely encouraged banks to
borrow, take risk and become “too big to fail.” Recent scandals —
JPMorgan’s $6 billion London trading loss, an HSBC <a href="http://dealbook.nytimes.com/2012/12/11/hsbc-in-record-settlement/">money laundering scandal</a>
that resulted in a $1.9 billion settlement, and inappropriate sales of
credit-card protection insurance that resulted, on Thursday, in <a href="http://dealbook.nytimes.com/2013/08/22/british-credit-card-customers-to-be-reimbursed/">a $2 billion settlement</a> by British banks — suggest that the largest banks are also too big to manage, control and regulate. </p>
<p>
NOTHING suggests that banks couldn’t do what they do if they financed,
for example, 30 percent of their assets with equity (unborrowed funds) —
a level considered perfectly normal, or even low, for healthy
corporations. Yet this simple idea is considered radical, even
heretical, in the hermetic bubble of banking. </p>
<p>
Bankers and regulators want us to believe that the banks’ high levels of
borrowing are acceptable because banks are good at managing their risks
and regulators know how to measure them. The failures of both were
manifest in 2008, and yet regulators have ignored the lessons. </p>
<p>
If banks could absorb much more of their losses, regulators would need
to worry less about risk measurements, because banks would have better
incentives to manage their risks and make appropriate investment
decisions. That’s why raising equity requirements substantially is the
single best step for making banking safer and healthier. </p>
<p>
The transition to a better system could be managed quickly. Companies
commonly rely on their profits to grow and invest, without needing to
borrow. Banks should do the same. </p>
<p>
Banks can also sell more shares to become stronger. If a bank cannot
persuade investors to buy its shares at any price because its assets are
too opaque, unsteady or overvalued, it fails a basic “stress test,”
suggesting it may be too weak without subsidies. </p>
<p>
Ben S. Bernanke, chairman of the Federal Reserve, has acknowledged that
the “too big to fail” problem has not been solved, but the Fed
counterproductively allows most large banks to make payouts to their
shareholders, repeating some of the Fed’s most obvious mistakes in the
run-up to the crisis. Its stress tests fail to consider the collateral
damage of banks’ distress. They are a charade. </p>
<p>
Dodd-Frank was supposed to spell the end to all bailouts. It gave the
Federal Deposit Insurance Corporation “resolution authority” to seize
and “wind down” banks, a kind of orderly liquidation — no more panics.
Don’t count on it. The F.D.I.C. does not have authority in the scores of
nations where global banks operate, and even the mere possibility that
banks would go into this untested “resolution authority” would be
disruptive to the markets. </p>
<p>
The state of financial reform is grim in most other nations. Europe is
in a particularly dire situation. Many of its banks have not recovered
from the crisis. But if other countries foolishly allow their banks to
be reckless, it does not follow that we must do the same. </p>
<p>
Some warn that tight regulation would push activities into the “shadow
banking system” of money market funds and other short-term lending
vehicles. But past failures to make sure that banks could not hide risks
using various tricks in opaque markets is hardly reason to give up on
essential new regulations. We must face the challenge of drawing up
appropriate rules and enforcing them, or pay dearly for failing to do
so. The first rule is to make banks rely much more on equity, and much
less on borrowing. </p>
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<p> <a href="http://www.gsb.stanford.edu/users/admati">Anat R. Admati</a>, a professor of finance and economics at the Stanford Graduate School of Business, is the <a href="http://bankersnewclothes.com/">author</a>, with <a href="http://www.coll.mpg.de/team/page/martin_hellwig">Martin Hellwig</a>, of “The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It.” </p>
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