Debt is a promise. After debt is put in place, borrowers and creditors must deal with it. Sometimes the burden imposed by the promise is too difficult or impossible for the borrower to bear. This is ...true for the debts of individuals and businesses, and sometimes also for government debt. The burden of the debt can cause problems for both borrowers and lenders, and sometimes also for third parties.
Consider Kate as an individual or as a business borrower. If Kate defaults on her debts, the legal consequences can be disruptive to her life and to her business. Kate might
Banking Dominos ANAT ADMATI; MARTIN HELLWIG
The Bankers’ New Clothes,
11/2023
Book Chapter
The global financial crisis that broke into the open in the summer of 2007 is often ascribed to excessive mortgage lending and excessive securitization of low-quality, subprime mortgages in the ...United States.¹ At the peak of the crisis, in October 2008, the IMF estimated that the total losses of financial institutions from subprime-mortgage-related securities amounted to $500 billion.²
When seen by itself, $500 billion seems huge, but in the context of a global financial system in which the banking sector’s assets are on the order of $80 trillion or more, it is actually not all that large. In fact, the
Too Fragile Still ANAT ADMATI; MARTIN HELLWIG
The Bankers’ New Clothes,
11/2023
Book Chapter
On Thursday, March 9, 2023, there was a depositor run on Silicon Valley Bank (SVB), at that time the sixteenth largest bank in the United States with total assets of more than $200 billion. On ...Friday, March 10, the Federal Deposit Insurance Corporation (FDIC) closed the bank, citing “inadequate liquidity and insolvency.”² SVB was the largest bank in the United States to fail since Washington Mutual in September 2008. Initially, the FDIC announced that insured depositors would be able to access again on Monday, March 13. After protests from investors with deposits above the deposit insurance limit of $250,000, Treasury
The Politics of Banking ANAT ADMATI; MARTIN HELLWIG
The Bankers’ New Clothes,
11/2023
Book Chapter
We opened Chapter 1 by quoting French President Nicolas Sarkozy angrily chastising U.S. bankers who had lost their “common sense.” From that quote one might assume that French banks are so tightly ...supervised that French bankers do not have a chance to lose their common sense.
In fact, French banks have been a major focus of concern in the European crisis. Throughout, they have had very little equity and a lot of short-term funding, in particular from U.S. money market funds. In 2011 the money market funds were worried about the sovereign debt crisis in Europe and withdrew their money.
Paid to Gamble ANAT ADMATI; MARTIN HELLWIG
The Bankers’ New Clothes,
11/2023
Book Chapter
When arguing against higher capital requirements, bankers and others routinely claim that having more capital would “lower returns on equity” (ROE).¹ These lower returns, they claim, would harm their ...shareholders and could “make investment into the banking sector unattractive relative to other business sectors.”²
Arguments against higher capital requirements that are based on such reasoning are fundamentally flawed. Such arguments ignore the basic connection between borrowing and risk, discussed in Chapter 2, and the basic connection between risk and required returns, discussed in Chapter 7. The arguments also say little to the policy issue because they neglect the need to
Some who are upset about the financial turmoil since 2007 are nostalgic for the good old days, when banking was simple and bankers were serving their local communities. A model for this nostalgia is ...the banker George Bailey in the 1946 movie It’s a Wonderful Life.¹ In the small town of Bedford Falls, New York, his Bailey Building and Loan Association enables working people to buy their own homes so that they no longer have to deal with Mr. Potter, the local real estate tycoon, who is thinking only about profits and is demanding extortionate rents from his tenants.
In
In previous chapters we discussed the many forms of supports and subsidies from governments that benefit banks and their creditors. These subsidies will be reduced if banks increase their reliance on ...equity funding as we suggest they should be required to do. In the last chapter, we saw that central banks also provide important supports. The supports and subsidies are key to understanding why the bankers who receive these benefits resist higher equity requirements so aggressively.
Debt is a promise. If debtors default on their promises, their creditors suffer. If the debtor is actually able to pay, creditors can take
