Are Banks Bluffing About the Danger of Banking Regulation?


Four and a half years after the passage of TARP, one thing is abundantly clear: The American public really, really hates bank bailouts. And yet, nearly three years after the passage of the Dodd-Frank financial reform bill, it remains unclear whether our financial system is significantly safer, and whether taxpayers are any less likely to have to bail out another large bank in the future.

That’s why an increasing number of voices on both sides of the political spectrum have been pressing for additional reforms that would reduce the chances that the federal government will have to step in to save another big, dumb bank.

Adding to this chorus are financial economists Anat Admati and Martin Hellwig with an important new book called The Banker’s New Clothes, which 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.

Banks don’t want to do that, because they generally fund their operations with disproportionate amounts of debt, and they maintain that their profitability — as well as our economy’s growth — depends on their continuing to do so. The central point of Admanti and Hellwig’s book is that these protestations are like the emperor’s new clothes: There’s simply nothing there. They write:

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