series. >> the bankers knew quote this is a new book by stanford professor anat admati. what's wrong with banking and what to do about it is the subtitle. professor what is the cartoon on the front of the book? >> it shows a few naked bankers just wearing ties and this mother and child kind of staring at them and it represents some of the content of the but

unfortunately. >> you open the book with the emperor's new clothes story. why? >> because it has a mystique to them. when people are dressed nicely and here they know what they are talking about, people think they might be missing something or they might not understand or it's just not good business to say something. it's more convenient not to challenge what they say but we try to back to the deutsch the opposite and expose the arguments, so "the bankers' new clothes" refers to arguments that are made that nonsense doesn't matter but this does. >> "the bankers' new clothes" the major reason for the success of bank lobbying is that banking has a certain mystique. there is a mnf that the banks are different from all other companies and industries in the economy. anyone who questions the claims that are made are at risk of being declared incompetent to

participate in the discussion. >> that's true. >> how strong is the banking lobby in the u.s.? >> very strong. after the crisis in 2009 senator durbin said wall street owns the place and the politics is all well different. but there is a big problem and that is what i learned more and more as i became involved. it's not about making valid arguments. it's not necessary or sufficient to be successful in the policy debate unfortunately because there are convenient narratives and some entrenched misunderstandings shockingly held by all kind of people 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 don't understand these things. but i think that's really weird. why wouldn't they understand the bread-and-butter finance and it's part of the mystique. sometimes when you going to banking you suspend all judgment. so here is the rest of the economy you have the companies and corporations they do things, they found what they do. banks are somehow different. they are allowed to say things you wouldn't think make any sense in other corporations and they just behave differently but somehow it is inferred that that is okay. >> one of the arguments to make its capital and you define those for people and what are the arguments you make about that? >> one of the most insidious things going on as everybody uses the ward capital.

and i really turns out most people don't understand what this means in the context of banking and because of the words that are used around it and the way the discussion is framed you are in an entirely different debate which is not that the date that is actually relevant. so you would read oftentimes that they are to set aside capital and the analogy is often made or the implication is made this is like a rainy day fund like a pile of cash that sits idle but that isn't what we are talking about. we are talking about how the banks fund what they do and maybe they do it with the board money or with money that most companies use which is retained profits and the shareholders' money used by the rest. you don't force anybody to fund the bank's people don't discuss

this almost everything you do and when you take the risk sometimes the investments don't work out and you can't pay your debt, and that is fundamentally what is wrong with banking it is a pervasiveness of essentially the conflict between the borrower and the creditor in this case tax payers. >> professor admati coming you right in here that bank debt is 90% plus of the bank's assets. is that too much? >> that is too much. we don't see companies fund that way and there is a reason for it. this funding is for some in the boroughs so much of a corporation that borrows so much. in fact any private government aboard a were is a little bit different. they have other ways may be to try to fund their debt payment but of course we aren't going to go into that in this discussion.

but any private borrower that gets so highly indebted starts being constrained on what they do or just a start in the way they make the decisions about what they do later about the risks they take and the kind of investment they are attracting and not attracting, distorted decisions because some of the down sides are borne by the creditor and if they can walk away from those debts they might have the private insurance they were the government pay or the central bank to give some support or whatever then the creditors are nicer to them than they would have been to other borrowers and that is how the banks get to them not as much as they do that other people kind of wouldn't be able to work with and choose to and the creditors would tell them not to and so the banks get into this position and what is pushing them is a basic tendency for the borrowing to become addictive and the fact

that we feed on the addiction and allow and encourage it perversely to keep doing it by encouraging harmful things as if we were to subsidize somebody polluting the river when they have a clean alternative is the really perverse system. >> anat admati teaches economics at the graduate school of business here at stanford university. professor admati, what role in your view did the banks play in the 2008 crisis? >> a major view. a day or other financial institutions, so it's not just what we might call the bank, but whenever investment banks, bank holding companies, an insurance company like a ig come of various financial institutions connected to one another and we explained in the dhaka that kind of set of dominoes right next to one another are very connected and got themselves to take a

rest in the various different ways to fool the regulators about what was actually going on and to meanwhile do very well for themselves and put the rest of us at great risk. the regulators were complacent because they like the good days when they lasted and allowed the risk to build up in a way that really was harmful, ended up being harmful. the reason we wrote this book is because they keep doing this. the crisis didn't result in appropriate lessons and regulations and so we are still in danger and wrote this book with great urgency and concern that we have the system that's just about as bad even if the times look good now be looked good in 2006, too or better now. certainly in europe we aren't even out of that crisis.

legacy, mortgage once come for closure. so we are not done with that. but of course one of the things we explain in the book is that when you borrow so much, even if you do a little bit, okay. it looks great because leverage tends to magnify the upside and downside so doing a little bit means seemingly really well but that's because the risk worked out this time. that is the risk. when we discover it didn't work out it's often too late. >> your author is martin hellwig, who is martin hellwig? >> i met him first when i was a graduate student in on a different topic was a little bit ahead of me and my dissertation had to do with some research that he is done in the early 80's and our paths have parted some time in the late 80's and he went on -- his from germany originally and then he was back

in the research institute on the public goods or something like that is quite appropriate for what we are trying to do here and what happened was after the crisis i started was going on and was their something to do about it or was it like an earthquake that we had to live through a perfect storm. i started reading through the narratives and the policy proposals. and the more that i looked, the more kind of disturbed i was. it started talking about academics and there was a whole part there that i don't know we will 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 and i started asking questions. when i read i can cross a lecture that martin gave about

the crisis and that made sense to me so i established contact in 2010 and we started exchanging views and ideas. i wrote something and what he said makes sense to me where a lot of the people said it did not and he was more involved in banking for 25 years so i'm a newcomer from the field of the corporate finance and the government looking into banking saying that is a really strange industry. very strange. and so to the point this would fail my students. this is an epigraph of the chapter.

it was shocking. in the spring of 2010, towards the summer i decided basically i've heard enough nonsense i wasn't going to just say something in the office and kind of complaint to my friends. and to keeping silent. anyway, i wasn't going to and then i called martin and i was alerted that there were some old things going on which is where the negotiations are taking place on the agreement on the capitol regulations and i was alerted by the people involved less started speaking out a little and asking questions that somebody needed to kind of right out with the issues or a round

of the debate and what people were saying was wrong. so he knew what more and more people were saying in banking so the four of us wrote in kind of little manifest during the summer and the book was a result of after that trying for year 24/7 to enter the debate and impact in the face of even for somebody from stanford, some difficulty feeling any impact when people didn't want you to have an impact so the book is basically going to a broad audience to say here is what the story is, what they are doing right or something more needs to be done here is our story how we want to teach you. >> who is the book written for? is this an academic textbook?

>> it's written at multiple levels at the same time. this is a serious book about banking and you don't have to go that way so you can read it as -- you don't need to know anything. we decided after a lot struggle how to enter with a mortgage. everybody is familiar with that and we need a certain language term. people need to understand what it means what happens when you didn't pay your bill, the notion of insolvency, liquidity. what do these mean. we avoided the jargon as much as possible so everything is in terms than you know pretty much or whatever is explained. then we delete the footnote which extends everything that is not essential for just reading through and really getting an

understanding of the underlying forces that are at play. what are the motivations of the people involved so we go to the heart of it and it isn't a crisis book. what i wanted to avoid is to start with the story of the crisis because i had to read a lot of crisis books i'm so sick of it i can't stand it so it's not about this crisis it is about the financial crisis but it's also not about the crisis it is about a system that is just distorted everyday because it isn't a healthy system. every day it can be muddling along. it can be even looking okay and to what is in a functional system to be added is distorting the economy to the did doesn't have its right place in the economy. so a lot of things are wrong with banking and there is a lot we can do about it but there is a lot of nonsense. >> historic we in your view has banking ever been right size or rightly positioned in our economy?

>> this inefficiency in banking i think it's basically fundamental. i don't think -- sometimes people say banking was always fragile. it's not this. it's not that. it's true that it's always been too fragile and you can understand that and we try to give a flavor for why that is. but it doesn't follow because of this fragile that it was ever really efficient as an industry because really what happens if you want me 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 the money to the banker. in the trade shows the banker there isn't a suitcase that you leave for safekeeping, you know, you just want your money back at

some point and so we lend the bankers the money and from that point on they have this money and they thought well there are also people needing loans. let's invest that money and of course there was a little spread they could take and the question is when they make loans or whatever it is they do with the money, some risk is taken. all kind of risks we go over. what could go wrong. well, things can go wrong and the question is what happens then. whose problem is it then. so 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 and that shows you the kind of cultural problem between the borrower and lender because the

borrower takes the outside when he comes, doesn't share it with the lender, the depositor asks the creditors and on the downside it's everybody's problem. they both suffer but so does the creditor in particular. now scale that forward. lots of things happen. sometimes banks are told by politicians only to invest in a particular area. there is always some agenda because banks are where the money is to be and 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, first of all they were not even for a long time, for 150 years they were not even kind of limited and corporations from the kind of corporations where shareholders can only lose with the invested for anybody that lent money for the collateral damage that happens. but there were private partnerships with their owners

being liable for everything and they get 50% of their funding from their own owners money and 50% from deposits. this is the middle of the 19th century. there were not corporations. and then as the 19th century developed and more corporations to place, the banks were actually not last because if they had a limited liability they could walk away and the deposits wouldn't be safe and they wouldn't serve as well. but still in the banking crisis in glass co the shareholders were broke, not the depositors because even in the u.s. boeing and the 20th century, there was depending on the state to double, triple liability for the bank owners and even shareholders and so you could actually lose as much as you invested or double that or even just be liable with your own assets if the bank lost money

and couldn't pay the notes. this is the four central bank. in any case, going then we had a depression and there were a lot of big huge problems in banking. the bank holiday, lots of runs on the banks, part of the mystery of the banks of this wonderful life, the rumor starts, everybody's standing in line and come all that suddenly is published the deposit insurance. the depositors kind of felt secure. and over the years convected topic of development of the banking, they stopped putting their own money or their owners money in, but our view to your original question is that the

banker never wanted to put enough of their own money and the way we tell the story is that somebody else can shares in you want to leave a little bit more in the edge. in other words, the borrower becomes a biased towards risk-taking and the first to say things because once the debt is in place, the creditor has a downside disproportionately from the upside and the up side gets magnified and belongs to the bar where to use chemical that said have we put in reforms since the 08 crisis and what would you like to see primarily as a reform? ceramica our analysis is that the system is fundamentally fragile. one manifestation of a problem everybody understands and talks about in this country is too big to fail. but we explain how this comes about. it comes about because certain institutions would have a lot of

systemic -- they would drop a lot of dominoes and spilled over to the rest of the economy. we solve lehman brothers failed that was small in comparison to the banks today. there was an effort that the banks will tell you resulted in the tripling its capital requirements. my favorite line on the tripling of the capitol requirements the always like to see how much bigger it is than the last time infraction is that they are so low as martin said troubling almost nothing doesn't give you a very large number. so 2% of something which isn't even all of the assets. now it's between 4.5 and seven. these numbers don't have the right number of digits and the backstop that's new is 3%. you do not find any healthy corporation or industry and

there is no reason the banks need to live like that. if they did with warren buffett does they could start building up their equity. >> what do you mean? >> i mean if you take a second mortgage on your house you delete 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 maintain all of your earnings, then you build up your equity. they do not borrow at all. other banks must borrow because they borrow from depositors and part of the 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 can't be more normalized like other corporations and have a minimum that they would demand from their barbour of 20 to 30% equity. instead the requirements allowed three or four of these kind of

numbers. so, they are so fragile that just a small loss would start getting people nervous or getting them to be less able to lend else well as pay their debt. they get into a situation the see the credit crunches that there is no reason for that. they don't lend when they lost from the previous investments. why don't we make them better prepared so when they lose next time it is and somebody else's problem but the people that got the up side. >> aren't banks different from other corporations? [laughter] >> there you go. they would like you to think that. they are not that different actually. they respond to the incentives that they are given and they are given what we allow them to do. the problem is that on this issue of the rest and on the issue of indebtedness they are corporations who are different

from other people in that we need them to be safe. therefore we end up providing them safety nets them make them more risky because it gives them incentives to take more risks and borrow more so they can get the upside and leave the downside to others. our job or the politician's job is to counter that addiction and this has been messed so we are putting ourselves in the box of the financial crisis like some disaster that happens by putting ambulances and having resolutions and living wills and all of that, well an ounce of prevention is worth a pound of cure is hour at the graph of the chapter of what to do. you can go in and tell them what to do and all that with the first and foremost a matter what else you do you have to straighten out the funding mix which is completely unnecessarily on healthy.

it is just allowing them to do everything more consistently and the reason that we are not doing it is because they somehow confused every decision makers to think that what we get used to it somehow the way that it should be giving it it's just wrong. >> anat admati serves on the fdic's estimate resolution that faizal committee which is what? >> this is part of the dodd-frank act. this is called title to and what it does is it creates an alternative to bankruptcy for more corporations. for more institutions that are called sestak. so right now since the creation the fdic knows how to take over failed small banks. the biggest it did was maybe washington mutual. 50 billion or whatever. now the fdic is in charge of in theory 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 will actually result, create some kind of process by which creditors will somehow be paid the essential functions would be maintained somehow and like they do for the small banks for the depositors are paid and a sell-off the pieces they would create a better bankruptcy than lehman brothers that's a drag on for four years and we've wasted everything that was even there. so whoever is deemed systemic we are not there and get but it could be any time they are charged with resolving them so i'm on a committee that is meant to advise on this process in the

kennedy with people like paul volcker and a number of other people. we need not that frequently but we have meetings in which we are presented 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 what i consider right now the best regulator in d.c. and the one most concerned with the public which is the fdic. so we ask the question can be e eliminate the problems just by being able to allow the companies to go into bankruptcy which is a normal thing or something like bankruptcy which is a normal thing a failed company does it to take on too much debt you go into bankruptcy. can we create something for banks that want of collateral

damage. that's the issue. it's pretty problematic. they have some things that are supposed to help like living wage but then i don't want to resolve you under bankruptcy said there are issues there. supposedly in title i there would be great supervision and cooperation. let me see the fdic is doing a great job trying to do this but it's not a point you want to get to. just a trigger by itself is a great when you get to the point you want to trigger this spigot has said in a meeting when we represented what the fdic would have done if it had the authority to resolve lehman brothers instead of sending them to bankruptcy it would've done a great. his question was what would you do after you did this on the first day and of course we had months to redo this and in the crisis it was not the same time and the policy makers would be

tempted to change it because it is a crisis. we don't want to get there. so the question is on the stock, is this an earthquake or not and the message in the book is this is not an earthquake. this is not a natural disaster. this is something you can do a huge amount to avoid and prevent and while you do that and also get a better, safer system, less of a store to the system, less loaded subsidy system. just about everything you can think of is good. and there's absolutely hardly anything you can think that is that unless you are a banker. >> we have been talking with anat admati, who's a professor of finance and economics of the graduate school of business here at stanford and university and the kuhl author of the new book "the bankers' new clothes" what's wrong with banking and what to do about it. you are watching book tv on c-span2. now an interview from book tv