RENEE MONTAGNE, HOST:

At a hearing last week, Attorney General Eric Holder admitted to senators why it's been hard to go after big bank executives.

(SOUNDBITE OF SPEECH)

ATTORNEY GENERAL ERIC HOLDER: It does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy. And I think that is a function of the fact that some of these institutions have become too large.

MONTAGNE: That startling comment may be news in Washington, where regulators gave a thumbs-up last week to nearly all the big banks, based on a stress-test of their ability to withstand a crisis. The attorney general's explanation is no surprise, though, to Stanford financial economist Anat Admati. She is coauthor of a new book called "The Bankers' New Clothes."

ANAT ADMATI: People are saying that the banks are too large, but the issue is really: Why would there be this negative effect on the world economy if he prosecutes them? And that's because they would somehow fail or get distressed. And why does that happen? That happens when you borrow too much. So it's not about too big to fail, but it's about the likelihood of failing, which is the likelihood of being somehow having difficulty paying your debt, just like homeowners might when they have very little down-payment or equity in their house.

MONTAGNE: One thing, speaking of regular folks, I mean, it had not really occurred to me, but you point out that of the debt that banks carry - and they carry about 97, 98 percent debt - say my savings account is basically a loan to the bank, a loan that I can take back at any time.

ADMATI: Exactly. Our deposits are kind of the starting point of their debt. They borrow from money market funds. They borrow from each other. They have other bondholders. They promise money in thousands of ways. They have ways to borrow in which they basically sell you something overnight, and then they promise to buy it back the next day. It's called repos.

MONTAGNE: So, back again, what you're saying and what the book is saying is that people think that maybe the complicated, obscure financial instruments that have come to be thought of as having brought the banks down, were really not the biggest problem. The biggest problem is something that continues on and goes on, and that's that banks simply do not have enough skin in the game.

ADMATI: Yes. And all of this is just living on the edge and not being prepared enough with your own money, indeed, to what might happen.

MONTAGNE: Well, what about all the new regulations that have gone into effect? Wouldn't any of them, or some combination of them, catch this problem?

ADMATI: So, the requirements now - which the regulators will tell you are so tough - actually still allow the banks to use borrowed money for 97 percent of their investment, and have just 3 percent equity. So even if it's a little more than that, just as a little bit more of a buffer, it's still not a healthy place to be.

MONTAGNE: But banks have said that if they have to have more money that hasn't been borrowed, that that would be a problem for them. They wouldn't be able to lend.

ADMATI: Well, but the statement's just false, that they can't lend. If they cannot raise money in the form of equity and they cannot with, say, 20 or 30 percent equity, then you have to wonder about the viability of their business model. So the equity does not prevent them from lending, but they might find it more beneficial to borrow, because it's subsidized. So if they live on subsidies, really, and they're telling us that they don't have a viable business with equity that's standard elsewhere, then probably there's too much banking, and they're has to be some shrinkage, which would be probably good for the economy.

MONTAGNE: What would you like to see to make the banking system more stable?

ADMATI: One obvious thing to do is to not pay dividends. This repeats mistakes that were made right before the crisis and all through the crisis, which is allowing banks to pay an amount of money. Just from 2007, until early 2009, and through the worst of the crisis, that was equivalent to half of the amount of the money in TARP that the government had to invest in the banks.

MONTAGNE: Beyond that, what broader things might the banks do to make them more stable?

ADMATI: I would like them to build up and maintain their ability to withstand losses to a much, much healthier range, so that we deliver to the public a stable and healthy system that can make loans and can do everything that we need it to do without being so distorted and dangerous.

MONTAGNE: Thank you very much for joining us.

ADMATI: Thank you for having me.

MONTAGNE: Anat Admati is professor of finance and economics at Stanford's Graduate School of Business. She's coauthor with Martin Hellwig of "The Bankers' New Clothes: What's Wrong with Banking and What to Do about It." There's an excerpt at npr.org.

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