>> next on book tv, stanford university professor anat admati said down with book tv to discuss her book "the banker's new clothes." the book takes a critical look at the banking industry and argues that the system can be made safer without adversely affecting the public. this 30-minute interview as part of book tv college series. ..

when people say something with a straight face and they are addressed nicely and they get here they know what they are talking about, people think they might be missing something or they don't understand or it's not good business to say something. it's more convenient not to challenge what they say. but we try to do the opposite than expos the full arguments. they have a whole collection of arguments that are made that actually sometimes doesn't matter but this does matter. >> a major reason for the success of bank lobby is that banking has a certain mystique. there's a pervasive myths that the banks are special and different from all other companies and industries in the economy. anyone that questions the claims that are made are at risk of being declared incompetent to participate in the discussion.

>> it's true. >> how strong is the banking lobby? >> very strong. after the crisis it was senator durbin who said frankly wall street owns the place. the politics is a little different, but there is a big political problem and that is what i learned more and more. it's not about making valid arguments. that is not -- it's not necessary nor sufficient to be successful in the policy debate. >> why? >> because there are convenient narrative's people prefer to have and they're seem to be also some entrenched misunderstandings shockingly held by all kinds of people who you would think should know better. so it's hard to sort out why people say what they say. some people say to me they just don't understand these things.

but i think that's really weird. why wouldn't we understand these bread-and-butter finance and it is part of the mystique. somehow when you go into banking you suspend all judgment. it's different. so here is the rest of the economy. you have a lot of companies and corporations that do things and they found what they do and banks somehow or different. they are allowed to say things that you wouldn't think make any sense to other corporations and they behave differently but somehow it is inferred that that is okay. >> one of the arguments you make in your book is about equity and capital. first of all you define those for people and what are the arguments you need for them? >> one of the most insidious things that is going on as everybody uses the word capital, capital regulations and talks about capital, capital. it really turns off people don't understand what this means, and

because of the way that the words are used are rounded and the way that the discussion is framed your sent off to an entirely different debate that is not actually relevant so you would read oftentimes that it is required to hold the capitol and set aside capital and the analogy is often made or the implication this is a rainy day fund but that is and what we are talking about. we are talking about how they find what they do and whether they do it with board money or money that most companies use which is retaining profits on the shareholders' money which is used by the rest of the economy. we don't force anybody to avoid borrowing. but people don't discuss this frequently. the fund almost everything they do with board money and when you take risks with borrowed money,

sometimes the investments don't work out and you can't pay the debt or become distressed and that is fundamentally what is wrong with banking is that it pervasiveness of a essentially a fundamental conflict of interest between the borrower and the creditor in this case the bar were and tax payers. >> professor b8 coming you right bank debt is often 90% plus of the bank's asset. is that too much? >> that's too much. we don't see the company is funded that way and there's a reason for it, this mix, somebody who borrows so much from the corporations borrow so much and any borrower, the private and the government are different. they have other ways may be to try to fund their debt payment but we aren't going to go into that in this discussion. but any private a borrower that gets highly indebted starts

being constrained on with a do or just distorted in the decisions about what the to leader about the risks they take and that the content, the distorted decisions and. like a corporation can walk away from the debt or might have the private insurance pay or the government pay or the central bank gives them support or whatever. then the creditors are nicer to them than they would have been to the other borrowers and that's how the banks get to borrow as much as you do that other people kind of wouldn't be able to or wouldn't choose to and they tell them not to, so the banks get into this position and fundamentally what is pushing them is a basic tendency for a bar were to become addictive and the fact that we feed on addiction and allowing

them to keep doing it by encouraging harmful things as if we were to subsidize somebody polluting the river when they have a clean alternative to the it's a very perverse system. >> host: anat admati teaches economics at the business of stanford university. professor admati, what role in your view did the banks play in the 2008 crisis? >> well, a major review. really they or other financial the institutions. so it's not just what you might call the bank, but what ever come investment banking and holding company, if it's an insurance company, various financial the institutions that were connected to one another and we explain in the book how that kind of dominoes right next to each other is very interconnected and they got themselves to take a risk and all of the various different ways to form the regulators

about what was actually going on there and to meanwhile do very well for themselves and put the rest of us at great risk. the regulators were complicity and the politicians because they liked the good days when they lasted and allowed them to build up in a way that really was harmful, ended up being very harmful. the reason we wrote this book is because they keep doing it, the crisis didn't result in appropriate lessons and regulations. so we wrote this book with a great urgency and concern that we have a system that is just about as bad. they looked good in 2006, too. certainly in europe we were not even out of that crisis and even in the u.s. we aren't out of the crisis. mortgage loans, for closure. so we are not done with that.

but of course one of the things that we explain in the book, too, when you borrow so much even when you do a little bit, okay. it looks great because the leverage tend to magnify the up side, so giving it a little bit well means doing it seemingly well and that is because the risks work out this time, that is the nature of the rest. it's often too late. >> who is martin? >> he's actually somebody that i met first when i was a graduate student in a completely different topic. he was just a little bit ahead of me and had to do with some research that he's done in the early 80's. and our paths have parted some time in the late 80's and he went on to -- his from germany and originally and then he was

back at their research institute for public goods or something like that is quite appropriate for what we are trying to do here. what happened after the crisis i started wondering what was going on in the financial system and why it created all these problems and was their something to do about it or was it like an earthquake we have to live through a perfect storm. i started reading the benner eda of san also on the policy proposals and the more that i looked, the more kind of tester dial was pitching in and talking academics and this whole part of their that i don't know we would get into, but i didn't like what i heard and i didn't like what i didn't hear, the fact i wasn't hearing certain things that seemed obvious to me. now, when i read, i came across a lecture that martin gave about the crisis and that made sense

to me. as i entered this and started riding high established contact with martin and early, 2010. we started exchanging views and ideas. what he said makes sense to me whereas a lot of other people said did not and he was involved in banking for 20, 25 years so i'm a newcomer from corporate financing governments looking into the banking saying that is a really strange industry. very strange. to the point that i opened a textbook and this is what the students in my class said as an epigraph of the chapter. it was shocking. in the spring of 2010, i decided

basically i have heard enough nonsense i wasn't going to just say something in the office and complained to my friends and just go out there. we were scared into it and keeping -- anyway, then i called martin, and i was alerted that there were some flaw the things going on which is where the negotiations were taking place for an international agreement on the capitol regulations. i was alerted by people involved which i started speaking out a little bit and asking questions that somebody needed to kind of ride out what the issues are around the debate and what people were saying is wrong. so i decided to include martin

because he knew what more and more people were saying in banking. so we rode in a little manifests during the summer and put it out there and that was the sort of start. they tried for a year 24/7 and impacted and the face even somebody from samford, feeling any impact when people didn't want it to have an impact. so they are going to an audience to say here is what the story is coming you judge whether they are doing it right or whether something more needs to be done. here is our story how we want to teach it. >> professor admati, who is the book written for? is this an academic textbooks? >> it has part of the that is an

academic textbooks at multiple levels at the same time. this is pretty much serious look about banking and yet, you don't have to that way. you can read it as a lead person coming you don't have to know anything. we decided that a lot of struggle it was a mortgage. everybody is familiar with that and we need a certain language term. people need to understand what it means to take that. what happens when you don't pay your debt and the notion of insolvency and liquidity problems. so we impact a leveling go around it, that we avoid a bud jargon as much as possible. so in terms of you know pretty much or what is knowingly explained. then we refer to the footnotes which are extensive. everything that is not essential for reading through and really getting and understanding of the underlying forces that are at

play. why are people wanting to do this? for the motivations for the different people involved so we go to the heart of it and it isn't a crisis book. but i wanted to avoid is to start with the crisis because i had to read a lot of the crisis. i am so sick of it i can't even stand it so isn't about this. it's about the financial crisis but it's also not about the crisis. it's about a system that is just distorted everyday because it isn't a healthy system. every day it can be muddling along and even looking okay and still isn't a functional system, it is the story of the economy. it doesn't have its right place in the economy. so i think a lot of things are wrong with banking and there is a lot we can do about it but there's a lot of nonsense. >> historical the in your view has banking ever been right size or write positioned? >> this inefficiency in banking i think is basically fundamental

para get i don't think -- sometimes people say banking is always fragile. it's not this or that. it's true that the banking has always been fragile and you can understand that and we try to give a flavor for why that is. but it doesn't follow that it was ever efficient as an industry or as -- because really what happened if you want to start with the teaching, start with deposits which we all know, like a road system like infrastructure. we want a payment system and to not carry around cash or gold or something like that. so that's how it started. giving them money to the banker. in the trade shows in europe, and the banker there isn't a suitcase that you leave for safekeeping. you know, you just want your money back at some point. so we lend them the money.

and then from that point on, the bankers had this money and they thought there are also people that needed loans so let's make loans and invest that money. of course there was a spread the they could take and when they make the loans or whatever it is they do with the money or the other things, some risk is taken which would go over. what can go wrong. well, things can go wrong and the question is what happens then. the word bankruptcy has the word bank, and it means broken bench. so when the depositor came and the money wasn't there, all they could do is break the bench of the banker and that shows you the problem between the borrower and lender.

he doesn't share it with the lender who is the depositor of the creditors. and on the downside, it's everybody's problem. they all suffered but so does the creditor in particular. now scale the problem of and move forward and lots of things happen. sometimes they are told to invest only in a particular area. there's always some agenda because they are where the money is. so they might sometimes be fragile because they are not diversified. sometimes they are fragile for other reasons but if you look at the history of banking, they were not for a long time. the shareholders can only lose what they invested and, you know, too bad for anybody that lent money and the collateral damage that happened. but there are private partnerships with of the owner being liable for everything and

they had 50% of the funding from their own owner has money and 50% from deposits to read this is the middle of the 19th century. they want corporations. then as the 19th century developed and more corporations took place, the banks were actually not last in that because of a the understood if they had limited liabilities they could walk away and then the deposits wouldn't be safe and they wouldn't serve as well. the banking crisis as we described it the shareholders were broke, not the depositors because they had to cover and even in the u.s. going into the 20th century, depending on the street there was double, triple liability for the bank owners and shareholders said you could actually lose as much as you invested or double that or even just be liable with your own assets if they lost money and couldn't pay the notes.

then and there were a lot of huge problems in banking. the bank holiday, lots of runs on the banks, part of them is a wonderful mary poperinge, the rumor starts. they established a deposit insurance so the kind of felt secure and over the years going back to the topic of development of the banking, they stopped putting their own money, but in our view they never wanted to put enough of their own money

and the way we tell the story with the guarantee is that somebody else can share on the downside is we want to leave a little bit more on the edge. the borrower becomes a little bit biased towards the risk-taking and first to say things because once it is in place, the creditor bears it down disproportionately from the upside and the up side gets magnified and belongs to the borrower. >> so all that said have we put in reforms since the 08 crisis and what would you like to see primarily as a reform? >> welcome to our analysis is that system is fundamentally fragile. one is that it's a station of the problem everybody understands too big to fail. but we explain how all of this comes about to get it comes about because certain institutions would have a lot of stomach and in other words, they would drop a lot of dominoes and spilled over to the rest of the

economy if they fail. we saw lehman brothers fail to the it was by comparison of the banks we had today. to answer the question, no pity that there was this effort that the banks would tell you resulted in the tripling of the capitol requirements triet my favorite line on the triple of the capitol requirements the like to see how much bigger it is on the attraction is the previous requirement for ridiculously low. trouble almost nothing it doesn't give you a very large number. so it was 2% of something called the rest asset that is more a bunch of them and now is between four and a half to seven. the numbers don't begin to have a number of digits. the next stop that is new is 3%. you do not find any healthy corporation or industry that is another reason the banks need to live like that if they did what

warren buffett does, they could retain their earnings and start building up their equity. >> what do you mean? >> if you take a second mortgage on your house, duty pledge your equity on the house. if you keep investing in your house value goes up and you do not take any money out, as a corporation if you retain all of your earnings the new build up your equity. they do not borrow at all. other banks must borrow because they borrow from depositors and part of what they do is to borrow but that isn't to say that they can't actually back up their liabilities without meeting the deposit insurance or support that they cannot be normalized like other corporations. they can't even have a minimum that they would demand from their barn over of 20 to 30% equity. instead, the requirements allow three or four of these kind of numbers. the are so fragile just a small

loss would start getting people nervous or getting them to be less able to lend than to pay their debt. they get into a situation we see the credit crunches and that is one thing we have to start investing that there is no reason for that. the reason the land is when they lost on previous investments. why don't we make them better prepared so that when they lose next time it isn't somebody else's problem. >> aren't banks fundamentally different than other corporations? >> there you go. [laughter] >> well, they would like you to think that. they are not that different actually. they respond to the incentives that they are given and in a precisely understand all will be given what we allow them to do. the problem is on this issue of risk and on the issue of indebtedness they are corporations who are different from other people in that we need them to be safe and

therefore, we end up providing them safety nets that make them risky because it gives incentive to take more risks and borrow more so they can get the oxide and leave the downside to others. our job or the politician's job is to counter that addiction as they are feeding at. and unfortunately, this has been nest. so we are putting ourselves in a box if you think the financial crisis is like some disaster that happens, you know, solving it by putting the ambulances and having a revolution and a living will and all that come an ounce of prevention is worth a pound of cure is the epigraph in the chapter on what to do. you can go in and tell them what to do and all that to get the first and foremost no matter what you do, you have to straighten out the funding next which is an necessarily unhealthy. fixing that is allowing them to do everything more consistently.

and the reason we are not giving it is because they somehow come to use every decision maker to think what we get used to is somehow the way that it should be giving it its trust wrong. >> anat admati also serves on the fdic's systemic resolution advisory committee, which is what? >> this is part of the dodd-frank act. this is called the title ii of the dodd-frank act. and what it does is it creates an alternative to the bankruptcy for more corporations. so right now for more institutions that are called systemic. so right now, all along, since the integration, the fdic knows how to take over the failed small banks. the biggest was maybe washington mutual. maybe 50 billion or whatever. now the fdic is in charge of in pherae taking down bank of america if need be. we are asked to trust that in a

crisis or not in a crisis the fdic which has the authority to do this and is probably the best to having this authority will actually results basically create some kind of a process by which the creditors would somehow be paid, is essential functions would be maintained, somehow and like they do for the small banks where they are paid and they sell off their pieces they would create a better mechanism than bankruptcy that is dragged on for four years and wasted almost everything that was there. and so, whoever is deemed a systemic and we aren't there yet but it can be any time they are charged with resolving them so i am on a committee that is meant to advise on this process and in this committee i've seen people like paul volcker and a number

of other people. so we meet not that frequently that we have meetings in which we are represented with progress on this issue and it's very good to be there because they get to ask a bunch of questions and work with basically the only -- what i consider now the best regulator in d.c. right now and the one most concerned with the public which is the fdic. so we asked a question could we eliminate the problems just by being allowed to have the company is going to bankruptcy which is a normal thing or something like bankruptcy that is another thing a company does if you take on too much debt the new can't pay your debt you go into bankruptcy giving it can we create something that won't have collateral damage. that is the issue. well, it's very problematic.

they have things in title i that's supposed to help like tell me how i would resolve under bankruptcy but then i don't want to resolve under bankruptcy so there are all kinds of issues there and supposedly in title i there will be great supervision and cooperation. this is a very -- let me just say the fdic is doing a great job of trying to do this but it is not the point that much to get to. just the trigger by itself is already too late. when you get to the point you are going to trigger this, as paul volcker said when we were presenting the fdic would have done if the had the authority to resolve lehman brothers instead of selling lehman brothers to bankruptcy, and it would have done a great. paul volcker's question was what would you do on monday to three and four on the first day and of course they had months to sort of reading this. and of course in the crisis they all feel that the same time. and the policy makers would be tempted to whatever law they made yesterday to change it because it is a crisis time.

.. >> "thebackers' new clothes: what's wrong with banking and what to do about it." you're watching booktv on c-span2. >> visit booktv.org to watch any of the programs you see here online. type the author or book title in the search bar on the upper left