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VERN MCKINLEY: The big banks have the support of the government. The big banks don't have to pay for their failure because they just get bailed out.
(SOUNDBITE OF SONG, "BELONG")
THE PAINS OF BEING PURE AT HEART: (Singing) What to do? Nothing new. We tried each other. Let's try another.
ADAM DAVIDSON, HOST:
Hello, and welcome to PLANET MONEY. I'm Adam Davidson.
CHANA JOFFE-WALT, HOST:
And I'm Chana Joffe-Walt. Today is Tuesday, February 7. And that was Vern McKinley, a financial policy adviser on MSNBC you heard at the top of the show. Today on the podcast, we're going to talk about how to create banks that we love, how to get all of you listening to this program to say - that banking system that we have in the United States, it is just great. That is coming up after our indicator with Jacob Goldstein. What do you have?
JACOB GOLDSTEIN, BYLINE: Today's PLANET MONEY indicator - 19 billion. U.S. consumer credit increased by $19 billion in December. That's according to figures the Federal Reserve released today. And this means people are borrowing more money to buy cars. It means they're borrowing to go to school. It doesn't include mortgages, which is of course a big piece of the debt picture.
But this $19-billion jump, it was much, much more than what economists were expecting. And, in fact, when you look over the past two months, the jump we've seen in consumer credit is actually the biggest two-month jump since 2001.
JOFFE-WALT: So I could see one way to think about this as a good thing - that people are borrowing to buy things more and buy cars and go out and spend money. It also seems like it could be a bad thing - right? - because, uh-oh (ph), people are falling too far into debt. And what I love about the indicator is I just get to ask you, Jacob. Good or bad, what should I feel about this?
GOLDSTEIN: Good. I'm going to say good.
JOFFE-WALT: Great.
GOLDSTEIN: And, you know, this is a hard, weird kind of question - do we feel good about U.S. consumers borrowing more money? But in this case, if you look at the broader context, it does seem promising. In particular, over these same few months that we're talking about, people's incomes went up. And the savings rate went up, right? So you have people making more money, saving more money and, you know, presumably feeling more confident.
JOFFE-WALT: So it's not that people are saving less and borrowing everything. It's that both things are actually...
GOLDSTEIN: Making more, saving more, and, you know - hey, I'm making more. I'm saving more. I'm going to go borrow money and buy a new car. And in the current economy, I'm going to say this is another promising indicator.
JOFFE-WALT: Great. Thank you, Jacob.
GOLDSTEIN: Thanks.
DAVIDSON: Thanks, man.
So onto today's show, our first crack at a major puzzle we've been wondering about here at PLANET MONEY. Is it possible - could we have a banking system we love? Could we have a banking system that provides good services to people at reasonable rates?
JOFFE-WALT: And one that does not bring down the entire world every few decades, you know, a banking system where people only get rich if they really do something great or are really smart.
DAVIDSON: I cannot think of anybody who I know other than people maybe who currently work at banks who would say, you know what I love? You know what I think is awesome? America's banking system. I mean, actually, the people I know who work at banks, they sometimes are the maddest of all. They really feel the banking system is outrageous.
JOFFE-WALT: Right. The only thing you might hear is, you know, somebody says that they love their neighborhood local bank or their credit union. But we're talking here about the banking system overall. How would we have a system overall that people said, we really, really love that whole system?
DAVIDSON: And we're going to introduce you to one woman who says - you know what? - I know how to make it into a system we all love. I know one little rule, just one rule that the government could change that would transform the entire banking system.
JOFFE-WALT: And that woman's name is Anat Admati. And she spends a lot of time in meetings like this one.
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UNIDENTIFIED PERSON #1: Is it possible to think about how you would think about Lehman under all of these authorities?
UNIDENTIFIED PERSON #2: Well, it's interesting you say that. We, of course, put a paper out last year regarding the Lehman insolvency.
JOFFE-WALT: This is from a meeting at the Federal Deposit Insurance Corporation - the FDIC in Washington, D.C. Those are the regulators that insure bank deposits. And in this room, we have regulators and academics who are sort of sitting around a big conference table talking about new ideas, about how to regulate big banks. And pretty much everybody at this table except for Anat Admati have been sitting at tables like this for decades, have been thinking about how to design the banking system for a very long time.
And Anat Admati stands out in another way. Just - she keeps interrupting. You know, somebody will be talking and presenting. And then Anat will go...
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ANAT ADMATI: Can I follow up...
UNIDENTIFIED PERSON #3: Please.
ADMATI: ...For a second on...
JOFFE-WALT: Just a few minutes later...
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ADMATI: Can I ask you another question?
UNIDENTIFIED PERSON #3: Please.
JOFFE-WALT: Sometimes she wants a clarification.
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ADMATI: So the guarantees are coming from where exactly? I mean...
JOFFE-WALT: Sometimes she wants to challenge whoever is speaking.
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ADMATI: Why isn't the conclusion that that must be increased a lot?
DAVIDSON: So, Chana, in this room - this room of advisers to the FDIC - there's Paul Volcker, probably the single-most-respected man in the history of banking regulations, certainly the modern history. There's Simon Johnson, former chief economist at the IMF who's been a major voice on banking regulation for quite some time.
And Anat Admati, she followed a very different path. In fact, she was not on any path that had anything to do with banking at all until one moment in 2008 when she read something, just one line.
ADMATI: I sat in my office. And I thought - something's really wrong in banking. Something's wrong.
JOFFE-WALT: We'll get to that line she read in just a minute. First, just some quick context. Anat Admati is a finance professor at Stanford. She teaches corporate finance, among other things. And back in 2008, when the economic crisis hit, you know, everybody in the world's completely confused about what's happening, what went wrong. We all have so many questions about it - Admati did, too. And this actually really surprised me. You know, she said finance professors, economists, they all felt exactly the same way as the rest of us did.
DAVIDSON: Confused. And that's something I've heard a lot too. Finance, like all of academia these days, is very segregated, very specialized. So you can be Anat Admati, someone who's been a finance professor for decades - quite successful, quite influential - and yet not really know almost anything about banks or how banks work. It just wasn't her area of research.
And then, all of a sudden, this crisis hits. For the first time in her life, finance is on the front page of the papers. It's in the news. Everyone she knows who probably was bored to death hearing that she's a finance professor desperately wants to talk to her, wants her to explain to them how this crisis happened, what's going on. And, for her, it's embarrassing and frustrating to realize - I actually - I have no idea.
ADMATI: It was a - it became the topic of, of course, every conversation, you know. So I was - I would, like, volunteer to lead lunch discussions on it. So we'd just talk about it a lot. It was just a lot of talking in the hallways, talking in the offices about it, just talking trying to understand. But as I started reading, I started asking various questions and started getting confused about why people were saying what they were saying and also why people were not saying certain things that seemed obvious to me.
JOFFE-WALT: Admati, remember, is a finance professor at Stanford. She teaches corporate finance 101. And banks are corporations. So she kept wondering - what are they teaching them down the hall in those bank finance courses? And, at this point, she actually went out and got a basic banking textbook. And this is where she read that sentence that changed the course of her career.
ADMATI: The textbook was written by Mishkin. You know, Mishkin was in the New York Fed. Mishkin, you know, is a famous banking expert. It was a sixth-edition textbook on banking. And I opened up on the chapter on the relevant stuff. I remember this very clearly because it was a very defining moment. And in the book, it said that banks don't want to have too much capital because it would reduce their return on equity. I sat in my office, and I thought - something's really wrong in banking. Something's wrong.
DAVIDSON: Admati was learning that banks are nothing like other corporations. And let's explain the major difference. I have here a list of some of the largest corporations in America. Like, let's see.
Intel, they have very little debt. They owe very little money out there. Google, Chevron, DuPont, Microsoft - very little debt. And then you hit the banks. Citigroup - huge amounts of debt. Bank of America - they owe over $682 billion that they've borrowed from bondholders and other banks. JP Morgan - $684 billion. Any one of these banks owes more than the size of most countries' entire economies.
JOFFE-WALT: So hugely different from companies like Intel, Chevron, Microsoft that have money on hand. They issue stock, and they get money. Or they make money. And they keep it on hand. They do not borrow a ton.
ADMATI: Nobody - nobody funds like banks. We're talking about, you know, very healthy, very productive, very happy companies that basically hardly borrow. They can go to equity investors, especially if they're a public company. Or they'd go to venture capital. Or there'd be lots of funding that people can get that's not in the form of IOUs, not in the form of borrowing. Apple has no debt at all, nothing.
JOFFE-WALT: No debt means a lot less danger. So if Apple goes out of business, it's one of the largest companies in the world. It would be painful for many, many people. But nobody is waiting for Apple to pay them back a huge amount of money. The world economy, if Apple collapsed, would survive just fine.
DAVIDSON: But banks are different. Banks owe way more money than they, themselves have. And that's what this crisis was all about. When one bank like Lehman Brothers - which isn't a particularly huge investment bank - got in trouble, the world realized, hey, Lehman Brothers owes billions of dollars to other companies, to other banks. So if they go down, maybe all those other banks are going to go down too.
JOFFE-WALT: But Admati is actually saying something that is maybe even more disturbing than banks being interconnected in this fundamental way. She's actually saying the banks don't care that much about this fact, about the fact that they could collapse and bring down the world economy. They don't have to because when the banks fail, the world's governments get so scared that they bail them out.
DAVIDSON: When times are good, the banks get all the upside of borrowing money and lending it out and keeping the interest. But when times are bad, at least if they're bad enough, bankers are not like regular corporate executives.
ADMATI: They don't care about the downside enough. Why? Because the downside is not theirs to bear.
JOFFE-WALT: Who's it to bear?
ADMATI: FDIC, us. You know, the downside of the banks is everybody's problem. We have gotten to a system where we have so much safety net that there isn't enough care. It's absolutely crazy.
JOFFE-WALT: So if we want a banking system we can all love, it would be one where bankers really, really don't want their banks to fail.
DAVIDSON: So here's where Admati has her proposal, how to fix all of this. Now, we should say, her proposal is not to tell the banks - screw it, you're on your own. If you get in trouble, we're not going to save you. We're not going to bail you out. Because she says, no, we do need banks. So if it gets to that point, the government will have to bail them out. And she's also not saying that banks should have no debt, they should be like Apple, just sitting on huge, extra money. She's just saying, of course you're going to have debt, but they should have less debt.
JOFFE-WALT: Exactly. So a big bank today maybe has $10 of its own money at any given time and would borrow $90. That $10, that 10 percent is called equity. And Admati says banks should have more of their own money at stake. They should have more equity, like $20 and then only borrow $80, say.
DAVIDSON: The banks who do not like this idea say - wait, we can't do our business if you don't let us borrow a lot more than the equity we have.
ADMATI: They can lend. They can take deposits. They can do everything with 20 percent equity. There's absolutely nothing, nobody - since I started saying these supposedly crazy things - nobody's ever given a reason why they cannot have 20 percent equity of the total balance sheet, nobody.
DAVID BEIM: My name is David Beim. And I'm a finance professor at Columbia Business School.
JOFFE-WALT: Here, of course, is someone who can think of at least one reason you do not want to require 20 percent equity.
DAVIDSON: Beim says banking is actually exactly as crazy as it seemed to Anat Admati that one day in her office. The basic business model of banking is to borrow a huge amount of money, lend it out and collect interest. That is how banks make money.
JOFFE-WALT: So Beim says if you say to banks you have to have more equity, which in banking is also called capital, it's basically the same thing as saying you can't borrow as much money, which in banking is the same thing as saying you can't make as much money.
DAVIDSON: And banks, of course, want to make money. They want to make profits. So if they have a smaller pile of money to do that with, they will take that smaller pile, and they'll make riskier bets.
BEIM: Because the riskier assets earn more. So it's perverse. You're telling them they ought to raise more capital. And then that means they're going to have to sell some shares. And somebody is going to have to buy the shares. And so everybody listening to this program should ask himself - supposing I were offered some shares in the bank but said I'm going to be really safe but I'm only going to return you 5 percent. That, for a stock, is considered very low. And so you might not buy that one. You might rather have a share of Apple or Google or something else that does a whole lot better than that.
DAVIDSON: Now, Admati says, no, the banks don't necessarily get more risky. They get smaller. They get more boring. Fewer people might see them as like a hot investment to make a lot of money. And that's exactly the point. We want banks that are sort of boring and safe and stodgy. And so in her view, this one rule, just changing this one regulation over how much capital, how much equity banks need to hold for every dollar of debt they borrow could instantly create a banking system that we would all love.
JOFFE-WALT: And this is where we always end up, Adam. This is the kind - whole conversation at that FDIC hearing was basically about this debate. You know, there's the one argument that's like, forget it. You know, we're stuck with crappy banks. It is inherent to banking. They get big. They take risks. They have so much political power. And we all rely on them so much that no matter what we do, the banks are going to be risky and big. And every once in a while, they'll collapse, get bailed out. We're all going to feel the pain. And then they'll just get richer. And that is how it is.
DAVIDSON: And then there's the Amdati argument, which says - no, no, no. Just look at the rules that govern banking. We can do this. We've done it before. We just need the right regulations. And that will make banking safer. And I've got to say, Chana, like, as a journalist ending on the - one side says this, the other side says the opposite...
JOFFE-WALT: I know. It's so painful (laughter).
DAVIDSON: It's so pain - it feels like failure. So I'm hoping that over the course of this year, we at PLANET MONEY can dip our toe in this issue of financial regulation. We're not there yet. But I'm hoping we can get an answer to this question - can we have a thriving banking system that is also safe?
JOFFE-WALT: And adored.
DAVIDSON: Safe and adored. It seems like a pretty high goal. But are there straightforward regulations that could make banking work or is it, at the end of the day, a fool's errand?
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THE PAINS OF BEING PURE AT HEART: (Singing) Among the fakes, you knew the pains.
DAVIDSON: So hopefully we're going to come back to this. Please send us your comments or questions, especially - is there anyone out there who just really loves America's banking system? We'd love to hear from you, planetmoney@npr.org.
JOFFE-WALT: You can find us at npr.org/money on Facebook, Twitter.
DAVIDSON: Spotify.
JOFFE-WALT: You're Adam Davidson.
DAVIDSON: And you're Chana Joffe-Walt.
JOFFE-WALT: Thank you for listening.
(SOUNDBITE OF SONG, "BELONG")
THE PAINS OF BEING PURE AT HEART: (Singing) We just don't belong. We just don't belong. We just don't belong. We just don't belong, don't belong, don't belong.
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