R. Admati, a professor of finance and economics at
Stanfordís business school, is an unlikely player in
Washingtonís financial reform scene.
58-year-old Israeli-born economist arrived at Stanford
in 1983 with an interest in mainstream financial issues
and a firm belief that markets ó with their unique
ability to assign a price to risk and channel capital to
its most efficient use ó were a powerful force for
2008 financial crisis upended that faith. She turned her
gaze to the industry at the center of the crisis:
made waves on the national financial reform scene in
2013 with the book "The Bankersí New Clothes:
Whatís Wrong With Banking and What to Do About
It," co-authored with economist and banking expert
conversational prose, the book patiently explains basic
banking concepts and forcefully argues for a new
paradigm of bank regulation, one that looks less at what
banks do with their money and more at where their money
comes from: Is it borrowed or their own?
argues that requiring banks to rely more on shareholdersí
money instead of borrowing funds would increase
stability, harness market forces to deter risky behavior
and lead to a smaller, safer system as banks pulled back
on bets that didnít make financial sense.
arguments have drawn fierce pushback from the banking
industry, but got the attention of financial
policymakers. They also earned her appointments to
advisory committees to the Federal Deposit Insurance
Corp. and the Commodity Futures Trading Commission, as
well as an invitation last summer to the White House.
whatís a bank to do? The Los Angeles Times recently
caught up with Admati, and hereís an excerpt of the
Why did you write "The Bankersí New
Clothes," a book for the general public and not
strictly for scholars?
We thought we had to. There was, I thought, a certain
lack of engagement on the part of many academics, and it
was disturbing to me that there was not enough serious
discussion about what was going on.
was not a banking expert, but after studying it, I found
that a lot of policymakers and people commenting on it
didnít actually know what they were saying or were
saying wrong things or misleading things.
seemed to be, to take a charitable interpretation, that
there were blind spots or confusion or, the most cynical
interpretation, there was sort of willful blindness.
How did you get so involved in Washington financial
From the beginning, I tried very hard to engage with
anybody in Washington who would engage with me. It
started by being appointed by Sheila Bair (then the FDIC
chairwoman) to a committee in the spring of 2011, which
just allowed me into the room at all. (Former Fed
Chairman) Paul Volcker is on it. (Dartmouth economist)
Peter Fisher is on it.
met Senate staffers, then Sen. Sherrod Brown (D-Ohio)
and other senators. Most of the people I met were
Democrats, but there were also some Republicans, like
David Vitter (of Louisiana). So, like that. It was just
developing, one person to another.
after the book came out, other people started paying a
little more attention, and thatís how I got even
invited to the White House.
So, whatís wrong with banking?
Whatís wrong with banking is that a lot of people are
able to take risks and not be fully responsible and
accountable for those actions. They can get away with
doing things that are really inefficient and dangerous,
somehow. And it works for them but itís dangerous for
the rest of us.
need to understand that the biggest banks are really,
really big, by any measure. Just how much is a trillion?
Itís an enormous number. They are larger than just
about any corporation, so itís not just big. Itís
really very, very big.
also the complexity and sort of breathless scope of what
they do and just how much of it is opaque. It remains
incredibly fragile as a system.
Why is a bankís equity important?
Equity is like a down payment on a house. Itís money
from shareholders, not borrowed, and thatís what most
corporations live on primarily. Some corporations donít
borrow at all.
question is, just how much reliance on debt should banks
Is it the same as bank capital, which we usually hear
Essentially, yes, but think of equity as the best form
of capital. Capital is often misunderstood as a rainy
day fund, money that sits on a shelf until it is needed
to absorb losses. Thatís false.
word "capital" is one of the worldís most
misunderstood words. When we talk about capital we think
in banking, and only in banking, the word
"capital" is meant to represent where the
money comes from. And really what regulatory capital
means is essentially money thatís unborrowed.
Capital requirements, boiled down, amount to a few
percentage points of a bankís total assets. Whatís
the right ratio?
Current requirements are ridiculous by any normal
standards. A supposedly "harsh" regulation
would be 5 percent of the total. Corporations just never
ever live like that.
talk about 20 percent-30 percent of assets, but whatís
really complicated is how you measure assets. The way
assets are measured now pretends to be scientific, but
the rules are designed in a flawed way. I want simpler
measures and for capital to be 20 percent-30 percent of
Where would banks get all this capital?
Stop paying dividends, for one thing. If you just invest
profits, you immediately have more money. Thatís how
Warren Buffett lives. He hardly ever pays out and just
invests it back in the business.
they donít have profits or canít raise equity by
selling stock, then you have to wonder about their
Youíve heard the argument many times from the finance
industry: The more capital you require, the more you
withhold from lending. Itís money taken out of the
Thatís ridiculous. Thatís utter nonsense. Youíre
talking about where the money comes from, not what they
can do with it. More capital does not constrain what
they do. It just makes what they do safer for the rest