Niskanen Center advisory board member and co-author of The Bankers’ New Clothes Anat Admati sat down with Russ Roberts of econtalk to discuss the decade following the financial crisis and the lessons that haven’t been learned.
When asked how her mind changed in the wake of the financial crisis, Admati gave one word: “assumptions.”
More specifically, she addresses Milton Friedman’s oft-cited argument that the telos of the corporation in a free-market system should be to maximize shareholder value subject to the rules and regulations established by policymakers. This model breaks down not only because there are monitoring problems for shareholders, but also because the rules themselves have been subject to regulatory capture.
Moral hazard also plays an important role. The comment of then-Wells Fargo CEO John Stumpf, who claimed that because the bank had so many depositors it was “self-financing,” is an excellent example of how moral hazard distorts our thinking about bank lending. Depositors are, in essence, lenders but depositors “feel safe because of deposit insurance. We do not breathe down his neck.”
The TARP bailouts, on which Admati is “agnostic,” are another example. Government can’t credibly promise to not bail out failing firms, creating a safety net for bankers in addition to one for ordinary depositors.
Admati’s points go beyond discussions of policy–her thesis is that the whole way we think about the financial sector is wrong. If any other industry were as heavily indebted as the financial sector, investors would get very nervous and those companies will feel the squeeze. Banks get a pass on being so heavily leveraged.
Regulators and academics weren’t just asleep at the switch–they were also drinking the kool aid. Admati describes their apologetics as “reverse-engineering” by examining the current state of the financial system and trying to explain why high leverage was necessary. Academics, seeking to become “big shots” will tell the interests invested in the current state of the financial system what they want to hear, and in turn their work is promoted.
There will always be “irrational exuberance” and human error, but it doesn’t need to be so heavily subsidized either due to the preferable regulatory treatment of leverage or the implicit promise of bailouts for troubled firms. Admati shows us that this isn’t just a policy problem, it’s a problem with the way we think about banking.
For a thorough discussion of the myths that still pervade our financial system, read Admati’s paper “It Takes a Village to Maintain a Dangerous Financial System.” You can find more of her research in our reference library.