Five Years of Financial Non-Reform

Sep 13, 2013 Anat Admati

Five years after the collapse of Lehman Brothers triggered the largest global financial crisis since the Great Depression, the world’s financial system remains dangerous and dysfunctional. Worse, despite years of debate, no consensus about the nature of the system’s problems – much less how to fix them – has emerged.

STANFORD – Five years after the collapse of Lehman Brothers triggered the largest global financial crisis since the Great Depression, outsize banking sectors have left economies shattered in Ireland, Iceland, and Cyprus. Banks in Italy, Spain, and elsewhere are not lending enough. China’s credit binge is turning into a bust. In short, the world’s financial system remains dangerous and dysfunctional.

Worse, despite years of debate, no consensus about the nature of the financial system’s problems – much less how to fix them – has emerged. And that appears to reflect the banks’ political power.

For example, Vince Cable, the United Kingdom’s business secretary, recently accused Bank of England regulators – whom he called “capital Taliban” – of holding back the country’s economic recovery by imposing excessive burdens on banks. Cable appears to believe the banks’ lobbyists when they claim that lending and growth would suffer if banks were forced to “hold more capital.”

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0 Comments on this paragraph, 9 Comments on this article

Per Kurowski Sep 15, 2014

Anat Admati writes: “Flawed regulations further distort weak banks’ behavior – for example, by biasing them in favor of making loans to governments or investing in marketable securities over lending to businesses.”

Flawed regulations, namely different capital requirements based on perceived credit risks that have already been cleared for in interest rates and size of exposures, distort the allocation of bank credit to the real economy of all banks, not just the weak.

If anyone is interested in the full version of what “risk-weighted capital requirements” really means, below is the link. Careful, it is scary.

http://subprimeregulations.blogspot.ca/2014/09/basel-ii-and-iii-risk-weighted-capital.html
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Jerry Miller Nov 7, 2013

Banks do both: they create money from thin air AND intermediate between lenders and borrowers. Put another way, a bank cannot possibly fund all its loans from thin air money: it has get some minimum amount of deposits (i.e. money from lenders) else it runs out of reserves.
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Ralph Musgrave Sep 16, 2013

Banks do both: they create money from thin air AND intermediate between lenders and borrowers. Put another way, a bank cannot possibly fund all its loans from thin air money: it has get some minimum amount of deposits (i.e. money from lenders) else it runs out of reserves.
- Ralph Musgrave Sep 16, 2013
  
  My comment starting "Banks do both..." was a reply to Stamatis Kavvadias (below). There was a temporary glitch with the Project Syndicate system.
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Stamatis Kavvadias Sep 15, 2013

Good motivation but the author does not understand money. There is nothing in banks to do with "financial intermediation". Banks create deposits, out of thin air, when they make loans. The world bank now admits this fact and that banks are special, by incorporating them in their models. This is precisely because banks *do not* intermediate finance: they create it from nothing. The associated risk puts its gains on the hands of bankers and its losses are left on the hands of society and regulators to manage.
- Ralph Musgrave Sep 16, 2013
  
  Banks do both: they create money from thin air AND intermediate between lenders and borrowers. Put another way, a bank cannot possibly fund all its loans from thin air money: it has get some minimum amount of deposits (i.e. money from lenders) else it runs out of reserves.
  A new reply to this comment has been posted.
A new reply to this comment has been posted.
Ralph Musgrave Sep 14, 2013

Good article by Anat Admati. Unlike many of the authors of Project Syndicate articles, I’ve been tempted into Googling her name to see what else she’s written.
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Gunnar Eriksson Sep 14, 2013

I do conclude from here that we must consider what politicians dare to do rather than what they should do. That Society should demand that vital organization/companies present a mission with strategic objectives for their operation. We would then be able to follow and measure performance.
As of now, banks conveniently jump from being a pillar of society to the pure gambling pursuit.
It is also so that organizations consist of people with an urge to achieve something! A clear mission will be a daily support in their actions
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Procyon Mukherjee Sep 14, 2013

The reform must start with spending habits itself that leads to the mountain of debt and the solution cannot go finding the next problem.

The jury is still out on fiscal policies whether or not they need to be counter-cyclical vis-a-vis being pro-cyclical, meaning that when the boom lasts, it is just the time to run down government spending or otherwise. It also holds true for the corporate sector or the household sector, the question looms, when does the spending needs to be tapered down?

Debt is a reflection of this drive for spending and investment, whether it is for a firm or a household. The fueling of this demand for debt by the banks (facilitated by the Central bank) is never left to the simplistic laws of the market, although it may seem that the demand for money and the supply would be matched by the interest rate as in classical theories. As the business cycle tends to lift the demand, the prices of assets in different clusters attract different classes of investors and speculators; the instruments that could mitigate risks come into play and some classes of assets are more volatile and recovery is difficult when market shocks take effect.

With too much money following too few goods as in an aftermath to the crisis, it would seem that supply of debt would need to be modulated, but on the contrary debt has grown even further for all classes of consumers; the principle of rolling over debt or restructuring debt or in the extreme case, events that lead to final debt auction to the highest bidder, are taken as normal denouements now, which may not have been such a simple affair even a decade back; the risks for the system is only mounting thereby.
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