The meme alert is flashing red: The debate over whether banks should boost their equity and reduce their leverage has begun to boil, though whether it can gain self-sustaining policy life, or submerge the way earlier proposals like nationalization, utility banking or even a strict form of the Volcker Rule have, is still in considerable doubt. But it's always fascinating to see these ideas, often buried in monographs or lectures, suddenly spring to life and race around the network trying to achieve takeoff.
In the Financial Times Thursday, Anat Admati, a financial economist at Stanford University, pens an op-ed
arguing that banks should not be raising dividends to shareholders, and should instead bolster their equity levels well above the current Basel III requirements. This is a developing thread in the larger breakup-the-banks thesis. Admati, with Peter DeMarzo, Martin Hellwig and Paul Pfleiderer, published a paper
in August entitled "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive." Last week Simon Johnson, both on The Baseline Scenario
and The New York Times' DealBook, began to promote the paper in a broadside against Goldman, Sachs & Co.'s report on improving business practices. Johnson linked the paper to a lecture presented by Bank of England Gov. Mervyn King in October, who approvingly cited it and a paper written by the BofE's David Miles. Johnson argued that the critique was generating "a great deal of mainstream traction," citing a speech by Miles on the BofE website and a recent meeting of the American Finance Association in Denver where "there was much agreement around the main points made by Professor Admati and the leading group of finance thinkers that recently wrote with her to the Financial Times on this issue."
The FT published Admati's letter
on Nov. 9, then apparently ordered up the column published today.
Meanwhile, Johnson has continued to beat the drum for the idea, this morning in a post
about Treasury Secretary Timothy Geithner's report, mandated by Dodd-Frank, "Study of the Effects of Size and Complexity of Financial Institutions on Capital Market Efficiency and Economic Growth," a title guaranteed to drive anyone but the most committed regulatory wonk to "Morning Joe." (As Johnson himself notes, of the report's 56 pages, only four or so involve the large and pressing issue of bank size, which does seem like a brush-off.) Johnson describes the paper as "analytically weak," and in fact on bank size Geithner really comes to no conclusion. But Johnson finds it particularly "shocking" that the Treasury secretary has not cited the Admati et al. paper, which he now describes as "definitive." (Johnson also manages to cite his book "13 Bankers
," now in paperback, three times in the post.)
There's a lot here to digest. The notion of boosting equity may well be a good one; too-big-to-fail, with its hidden subsidies and systemic threat, certainly looms as an unresolved issue, although those who believe Dodd-Frank's resolution authority will take care of business in the event of disaster deny that. Geithner's report will change no one's minds, reinforcing the argument made by University of Pennsylvania Law School's David Skeel in "The New Financial Deal
" that Dodd-Frank represents a triumph of a corporatist partnership between big banks and the government. But stepping back, what strikes one is how technical, indeed technocratic, these debates are on issues with large consequences. Admati et al. wrote a single academic paper on an issue that, to anyone outside (and many within) finance, will seem narrow and arcane. Discussion ensues, but it is almost purely among fellow members of the economist's guild. Then the idea begins to seep outside the academy and the regulatory establishment, where we are told that it is "definitive" or that it's getting "mainstream traction" or "there was much agreement." Credentials are offered, bona fides presented, which grow more potent as the distance from the source increases. Once loose, judgments on this idea begin to resemble the views of the Keynesian beauty pageant, that is the relativistic market, leaving outsiders floundering.
That is not to say Admati, King, Miles, Johnson or any other members of the financial economist "mainstream" (Paul Krugman is bound to appear) are necessarily wrong. It is to say that making informed judgments on these matters, even with some interest and knowledge, is very difficult. This is a much larger question than just whether banks can afford to boost equity; it goes to the heart of national regulatory policies that are built on uncertain, contingent and obscure economic and business matters -- matters that, one cannot forget, most economists got dreadfully wrong in the recent past. The issues are technical; the repercussions widespread; and the translation to the great mass of democratic souls are beyond faulty. You end up, however, with the simplest of questions commonly heard around elections: Whom do you trust? - Robert Teitelman