Tuesday, August 27, 2013

Banks are still dangerously overleveraged

Stanford business professor of finance and economics, Anat R. Admati, reminds us that the financial system has not really been reformed, that the banks that are too big to fail are still too big to fail, too big to regulate, and too big to manage.  They have successfully defeated banking reform in the U.S. and around the world, the world economies are still at risk, and taxpayers will pay if and when their reckless gambling with other people’s money fails catastrophically.  2008 is waiting to happen again.

The one fundamental solution she proposes is to require banks to increase the percentage of equity.   Her key sentence:

“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.”

Another interesting point she makes is that other corporations rarely have debt of more than 70% of assets, whereas the banks are well over 90%.  So, when they lose just a little it has the effect of shaking the viability of the bank to the core, and in  2008, only the government could rescue them with taxpayer money.  Heads they win, hundreds of millions and billions for individuals in the banks, tails we lose, multiple billions in bailout taxpayer money.

Her hope:

“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.”

Sounds like sound advice to me.