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

by Anat Admati and Martin Hellwig Princeton University Press
Pub Date:
Pbk 424 pages
AU$49.99 NZ$52.17
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The past few years have shown that risks in banking can impose significant costs on the economy. Many claim, however, that a safer banking system would require sacrificing lending and economic growth. The Bankers' New Clothes examines this claim and the narratives used by bankers, politicians, and regulators to rationalize the lack of reform, exposing them as invalid. Anat Admati and Martin Hellwig argue that we can have a safer and healthier banking system without sacrificing any of its benefits, and at essentially no cost to society. They seek to engage the broader public in the debate by cutting through the jargon of banking, clearing the fog of confusion, and presenting the issues in simple and accessible terms.

Preface to the Paperback Edition ix
Preface xiii
Acknowledgments xvii
1The Emperors of Banking Have No Clothes 1
PART I Borrowing, Banking, and Risk 15
2How Borrowing Magnifies Risk 17
3The Dark Side of Borrowing 32
4Is It Really "A Wonderful Life"? 46
5Banking Dominos 60
PART II The Case for More Bank Equity 79
6What Can Be Done? 81
7Is Equity Expensive? 100
8Paid to Gamble 115
9Sweet Subsidies 129
10Must Banks Borrow So Much? 148
PART III Moving Forward 167
11If Not Now, When? 169
12The Politics of Banking 192
13Other People's Money 208
Notes 229
References 337
Index 363

Shortlisted for the 2013 Spear's Book Award in Business 'Insightful . . .'--Floyd Norris, New York Times 'mportant . . .'--John Cassidy, 'Crucial . . .'--Jim Surowiecki, 'Ms. Admati and Mr. Hellwig, top-notch academic financial economists, do understand the complexities of banking, and they helpfully slice through the bankers' self-serving nonsense. Demolishing these fallacies is the central point of The Bankers' New Clothes.'--John Cochrane, Wall Street Journal 'Professor and journalist Admati and economic researcher Hellwig argue that it is possible to have a well-balanced banking system without any cost to society; weak regulations and lax enforcement is what caused the buildup of risk unleashed in the crisis. Here, they aim to demystify banking and expand the range of voices in the debate; encouraging people to form opinions and express doubts will ensure a healthier financial system as people understand the issues and influence policy. . . . The authors push for aggressive reform by outlining specific steps that can be taken to change our banking system for the better.'--Publishers Weekly 'An important book for readers interested in what has been done, and what remains to be done, when it comes to safeguarding financial institutions.'--Kirkus Reviews 'This book's aim, decisively achieved, is to de-mystify the public conversation about banking so we can all understand how threadbare the industry is.'--Diane Coyle, Enlightened Economist blog 'This title is a must read for management and human resource professionals within the banking industry as well as government policymakers. With its clear explanations, many examples, and analogies, the book is accessible to readers who do not have business backgrounds and who want to better understand banking.'--Library Journal ' owerful. . . . The authors persuasively argue that the solution is higher levels of equity capital throughout the banking industry to offset the impact of the implied government protections against failure.''s Free Exchange 'Ms. Anat 'gets' banking, and gets it better than most. The fact that she is ruffling feather relates more to the fact that she is questioning deeply held--yet hardly ever challenged--belief systems within the industry, than any lack of understanding.'--Izabella Kaminska,'s Alphaville blog 'Admati and Hellwig have done something extraordinary. They took frustration and all its complex details and gave it a simple narrative, one that both explains what banks have been getting away with and what we might ask that Congress do about it.'--Brendan Greeley, Bloomberg Businessweek 'Admati and Hellwig offer a simple prescription for this complex world . . .'--Thomas G. Donlan, Barron's 'Anat Admati and Martin Hellwig are academics with a gift for taking the mind-numbing minutiae of banking and presenting it in a way that the average reader can understand. One by one, the self-serving protests of the banking industry against tougher regulations are lined up and struck down in The Bankers' New Clothes. . . . The authors map out the regulatory flaws that make it easy for debt-junkie bankers to get rich when times are good, and leave them hanging around protesting when times are worse thanks to their own recklessness.'--Susan Antilla, Bloomberg News 'Admati and Hellwig explain, in layman's terms, some of the silly arguments bankers make for keeping to the status quo and preventing any new regulation of the banks from ever being enacted. And they do a great job. . . . Admati and Hellwig have made a gift to you. You don't have to go wrestle with banks' financial statements or their annual reports or their 10Q's. You don't need to pull out your old accounting textbooks or call your college economics teacher to have her explain to you again why debt leverage increases risk. Admati and Hellwig have done all the hard work for you. But, you have to read their book.'--John R. Talbott, Huffington Post 'The Bankers' New Clothes is wowing critics of fragile banks with a simple and attractive message: Force banks to have much thicker cushions of capital and you can make them safer without paying any cost in terms of higher interest rates, less lending, or lower economic growth.'--Peter Coy, Bloomberg Businessweek 'Financial regulation has become a hot topic in the wake of the recent crisis; many complex proposals have ensued, and a dizzying array of new acronyms and agencies has emerged. But in their new book, Admati and Hellwig make a forceful case for a classic and simple solution to excessive, unregulated lending: higher capital ratios for banks.'--Finance and Development 'An excellent new book . . .'--Matthew Yglesias, 'n important new book called The Bankers' New Clothes . . . offers what the Dodd-Frank legislation mostly lacked: a simple and elegant solution to the problem of financial stability. They argue that banks should fund themselves with more equity and less debt--or, to put it bluntly, that banks should risk more of their own money, and less of everyone else's.'--Christopher Matthews, 'Admati and Hellwig don't just criticize bankers. The real strength of their book is that they walk their readers through the balance sheet and to a regulatory answer to the banking problem, an answer that's elegant in its simplicity and far-reaching in its potential to prevent and manage financial crises.'--Randolph Walerius, Roll Call 'The most important to emerge from the crisis. . . . The authors achieve three things. First, they explain basic financial theory with simple examples that any moderately numerate individual can understand. Second, they show that these basic ideas apply, with modest differences, also to banking. Finally, they prove that, in opposing them, bankers and their apologists have spun intellectual raiment as invisible as the emperor's new clothes. . . . Read this book. You will then understand the economics. Once you have done so, you will also appreciate that we have failed to remove the causes of the crisis. Further such crises will come.'--Martin Wolf, Financial Times 'The Bankers' New Clothes (Princeton University Press) is a book that lays out the problems in banking revealed by the crisis and asks how to solve them. The authors, Anat Admati and Martin Hellwig draw upon accounts of the crisis and come up with some clear prescriptions based on what they see as the biggest problem--that banks are over-leveraged.'--Nick Dunbar, 'Admati and Hellwig's analytical rigour is convincing. . . . The value of The Bankers' New Clothes is that it sets all out in clear and accessible terms over little more than 200 pages, without cutting corners.'--George Hay, Reuters Breakingviews 'Increasing capital is the most sure-fire way of improving financial stability. Indeed, a new book--The Bankers' New Clothes--cogently argues that equity/debt ratios in banks could and should be increased drastically to levels more like those of ordinary businesses.'--Richard Saunders, Financial News 'One can only hope that non-financial readers who want to improve the focus of their frustration will find their way to this book. Perhaps, then, policy-makers will start to feel pressure for smarter change.'--Peter Morris, Financial World 'Many readers may feel their stomachs sink at the mention of capital ratios and systemic risk. But Anat Admati, a finance professor at Stanford University, and Martin Hellwig, a director at the Max Planck Institute for Research on Collective Goods, have done an admirable job in explaining how capital in the banking system works to absorb shocks, and how too little of it makes banks unstable.'--Economist 'The authors have written the book for the enlightenment of the average reader who has no background in economics, finance or quantitative fields. But it can be read by anyone interested in banking--bankers, policy makers and researchers.'--Business Standard ' a clearly written, sensible analysis of problems and cures for the U.S. banking system. . . . Admati and Hellwig take a lot of time to clearly explain the problems with depending too much on borrowed money . . .'--Dale Singer, St. Louis Post-Dispatch 'The Bankers' New Clothes is a lucid exposition of the intellectual falsehoods deployed by banks to justify the ways in which they went about growing their business beyond any reasonable assessment of risk in the run-up of the crisis of 2008 and which they continue to peddle today. Admati and Hellwig cut through the debates about whether it was too little or too much regulation that was to blame, whether central banks could and should have acted faster, and the rights and wrongs of securitisation or separating commercial and investment banking, and go to the heart of the matter.'--Will Hutton, New Statesman 'hought provoking . . .'--Heather Stewart, Observer ' case that the banking industry still needs a shake-up is persuasive. And you have to admire their nerve in tackling the lobby head-on because, like the emperor in the Hans Christian Andersen fairytale, it wears a smokescreen of competence and confidence. Attacking the illusion takes courage.'--David Wilson, South China Morning Post 'A clear and detailed call for banking reform. Arguing that the system is no safer today than before the financial crisis, the authors reject some bankers' and politicians' fears that further regulations would be too expensive and instead call for extensive change. Their starting place: Make banks responsible for their own mistakes.'--Worth 'One of the greatest strengths of this book is that it clearly explains the issues for the ordinary reader. Financial reform shouldn't be left solely to Wall Street bankers and their captured policymakers in Washington, D.C., to decide. Regular citizens must make their voices heard, and this book will help them understand the basic terminology and concepts. I encourage everyone with an interest in effective financial reform to pick up a copy today. This just might be the most important book of 2013.'--John Reeves, Motley Fool 'Offering a unique insight into banking from both an insider's and layman's perspectives, The Bankers' New Clothes is a welcome source of information in these unstable times.'--Noori Passela, The National 'The Bankers' New Clothes . . . is critical and refreshing. Anat Admati and Martin Hellwig are a formidable pair and systematically demolish all the bankers' arguments on risk, capital buffers, reserve requirements and the claims that no further reforms are required.'--Hazel Henderson, Seeking Alpha 'Admati and Hellwig walk banking neophytes slowly through how banking works, framing examples in a way that most people can understand: borrowing on a home. In very simple terms the authors explain how excess leverage is dangerous. Ironically, bankers are quick to point this out when examining someone else's credit prospects but not necessarily their own.'--Douglas French, Freeman 'he banks' argument that equity capital is expensive and that increasing equity capital would force them to pass up otherwise attractive lending opportunities has been systematically demolished, most notably by the academics Anat Admati and Martin Hellwig. In a new book they argue . . . that both the equity and debt of well capitalised banks are safer and thus cheaper, while a lower return is perfectly acceptable to investors in exchange for lower risk.'--John Plender, Financial Times 'Since the 2008 financial crisis, there has been a continuing conversation on large banks and the idea of institutions that are 'too big to fail (TBTF).' Anat Admati and Martin Hellwig have provided a valuable contribution to the debate in their new book, The Bankers' New Clothes. . . . This is a timely and interesting book and one that is squarely in the middle of the debate over the future of the nation's largest banks.'--Christopher Whalen, National Interest 'I've read almost all the major books on the financial crisis, and what makes this one of the best, if not the very best, is its simplicity and accessibility.'--Emre Deliveli, Hurriyet Daily News 'The book pounds quite the drumbeat here: Force banks to borrow less (they should make up the difference through issuing more equity stock) and so inject sanity into the system.'--Katharine Whittemore, Boston Globe 'In simple and accessible terms, the authors show convincingly that banks are as fragile and destructive as they are, not because they must be, but because they want to be--and they get away with it.'--Shanghai Daily 'The Bankers' New Clothes . . . stands out from the crowd. For one, it does not beat around the bush--it is clear and straight to the point in an industry usually heaving with jargon. By using language the man on the street can understand, this bold book leads quite literally by example as it reveals insights into the banking industry and why it is in such a mess.'--Nina Roehrbein, Investment and Pensions Europe 'This is the most important book to have come out of the financial crisis. It argues, convincingly, that the problem with banks is that they operate with an order of magnitude too little equity capital, relative to their assets. Targeting return on equity, without consideration of risk, allows bankers to pay themselves egregiously, while making their institutions and the economy hugely unstable.'--Financial Times, 'Books of the Year So Far' Summer Reading Guide 'The book deserves to be read by both bankers and policymakers as it debunks many of the myths that have been used to justify excessive leverage in banking.'--Economic and Political Weekly 'This excellent volume provides an invaluable lens through which to view modern banking and the ways it has evolved to privatize returns and socialize risks. . . . Admati and Hellwig provide an accessible explanation of the inherent risks in the current banking system and propose sensible rules and reforms to make the system stable without damaging bank lending or economic growth.'--Choice 'This accessible look into complex financial theory is a must-read for anyone interested in the ongoing debate over regulatory reform and 'too big to fail.''--Jeanine Skowronski, Deputy Editor, BankThink 'he Bankers' New Clothes makes a powerful case for why banks should stop borrowing so much.'--Rana Foroohar, Time 'uy this book; read this book; give this book to your friends; discuss this book; act on this book.'--Carol Hunt, Irish Sunday Independent
Anat Admati is the George G. C. Parker Professor of Finance and Economics at Stanford's Graduate School of Business. She serves on the FDIC Systemic Resolution Advisory Committee and has contributed to the ''Financial Times'', ''Bloomberg News'', and the ''New York Times''. Martin Hellwig is director at the Max Planck Institute for Research on Collective Goods. He was the first chair of the Advisory Scientific Committee of the European Systemic Risk Board and the cowinner of the 2012 Max Planck Research Award for his work on financial regulation.