Bloomberg Audio Studios, Podcasts, Radio News.

Bloomberg Audio Studios, Podcasts, Radio News.

Hello and welcome to another episode of the Odd Thoughts podcast. I'm Tracy Alloway.

Hello and welcome to another episode of the Odd Thoughts podcast. I'm Tracy Alloway.

And I'm Joe. Wasn't all Joe.

And I'm Joe. Wasn't all Joe.

It is coming up to the one year anniversary of last year's banking drama. I'm still not sure if we can call it at crisis or not. Uh, it kind of felt crisis at the time, but.

It is coming up to the one year anniversary of last year's banking drama. I'm still not sure if we can call it at crisis or not. Uh, it kind of felt crisis at the time, but.

It went away so fast. You know what the funny thing was, and I've mentioned it is it is that cliche or I don't know a thing that people say the FED is going to keep hiking rates until something breaks. He's like, here's the break. It happened, and then it was like a blip. It's like nothing. And then the Fed kept hiking and stocks kept going up, and everyone forgot about it. So it's kind of weird that something that dramatic could happen and seemingly then just sort of get forgotten about kind of quickly.

It went away so fast. You know what the funny thing was, and I've mentioned it is it is that cliche or I don't know a thing that people say the FED is going to keep hiking rates until something breaks. He's like, here's the break. It happened, and then it was like a blip. It's like nothing. And then the Fed kept hiking and stocks kept going up, and everyone forgot about it. So it's kind of weird that something that dramatic could happen and seemingly then just sort of get forgotten about kind of quickly.

Well, one of the most dramatic things that happened out of all of that, I thought, was when they basically just guaranteed everyone's deposits, right, So we know at this point that you are supposed to have up to two hundred and fifty thousand dollars of your deposits at any bank or any bank that's FDIC guaranteed. Basically those are safe. If the bank goes under, you get that money back. But then we saw that Silicon Valley Bank went under and people had more than two hundred and fifty thousand dollars in their accounts and they got bailed out, which is kind of phenomenal. I don't think we talk about the deposit guarantee the aspect of that whole thing enough.

Well, one of the most dramatic things that happened out of all of that, I thought, was when they basically just guaranteed everyone's deposits, right, So we know at this point that you are supposed to have up to two hundred and fifty thousand dollars of your deposits at any bank or any bank that's FDIC guaranteed. Basically those are safe. If the bank goes under, you get that money back. But then we saw that Silicon Valley Bank went under and people had more than two hundred and fifty thousand dollars in their accounts and they got bailed out, which is kind of phenomenal. I don't think we talk about the deposit guarantee the aspect of that whole thing enough.

We talked about it at the time, and I think this was the interesting thing, and you're right, this is the sort of the bigger thing that has been swipped under the rug, which is if all deposits and all US banks are implicitly federally backed, then do we need to rethink the business of banking? If this huge source of finance, if it's all guaranteed in the end, then it's like, why do we allow these banks to operate as there? That was a big question. We talked about it in March and April and May, and that's still unresolved. But people have really moved on from that question. But it really is fundamental.

We talked about it at the time, and I think this was the interesting thing, and you're right, this is the sort of the bigger thing that has been swipped under the rug, which is if all deposits and all US banks are implicitly federally backed, then do we need to rethink the business of banking? If this huge source of finance, if it's all guaranteed in the end, then it's like, why do we allow these banks to operate as there? That was a big question. We talked about it in March and April and May, and that's still unresolved. But people have really moved on from that question. But it really is fundamental.

Not us.

Not us.

We are still living in spring of twenty twenty three, so I'm very pleased to say we do, in fact have the perfect guest to discuss this. You might remember we spoke with Stephen Kelly a couple weeks ago about how the way we're bailing out banks or supporting them with various liquidity facilities is changing. In this episode, we are going to be focusing on getting to a point where you don't actually have to bail out the banks. Let's just avoid this problem altogether. And I'm very pleased to say with us now we have a not at Madie. She is, of course an economist and professor at the Stanford Graduate School of Business. She has written prolifically on this topic for at least as long as I can remember at this point, certainly since the two thousand and eight financial crisis. And thank you so much for coming on all.

We are still living in spring of twenty twenty three, so I'm very pleased to say we do, in fact have the perfect guest to discuss this. You might remember we spoke with Stephen Kelly a couple weeks ago about how the way we're bailing out banks or supporting them with various liquidity facilities is changing. In this episode, we are going to be focusing on getting to a point where you don't actually have to bail out the banks. Let's just avoid this problem altogether. And I'm very pleased to say with us now we have a not at Madie. She is, of course an economist and professor at the Stanford Graduate School of Business. She has written prolifically on this topic for at least as long as I can remember at this point, certainly since the two thousand and eight financial crisis. And thank you so much for coming on all.

Thoughts, Thank you so much for having me.

Thoughts, Thank you so much for having me.

You know, we needled Stephen a little bit when he was on the show by just throwing out the yes. So I'm going to do the equivalent for you and say, how do banks hold capital?

You know, we needled Stephen a little bit when he was on the show by just throwing out the yes. So I'm going to do the equivalent for you and say, how do banks hold capital?

Oh my god, that word is a trigger because because that word leads to so much confusion. So I'm glad you started with that. A senator would say it's money on the sideline. Newspaper articles explain it as cash like asset, and it's not true. What we're talking about this hold capital is not something that actually the banks hold. It's something that investors hold. In fact, what they do hold is those reserves in the Central Bank on which they get five point four percent. That's what they hold. That's what's out of the economy set aside. What we're talking about is just like deposits. On the funding side, we're talking about equity funding for banks, an amazing idea in banking that you would actually need any of it. And guess what they live like no corporation lives, and no corporation needs to live. But they're there because you know, I have a lot of research on leverage and leverage addiction, and it's just there at the point of such heavy indebtedness that they hate coming out.

Oh my god, that word is a trigger because because that word leads to so much confusion. So I'm glad you started with that. A senator would say it's money on the sideline. Newspaper articles explain it as cash like asset, and it's not true. What we're talking about this hold capital is not something that actually the banks hold. It's something that investors hold. In fact, what they do hold is those reserves in the Central Bank on which they get five point four percent. That's what they hold. That's what's out of the economy set aside. What we're talking about is just like deposits. On the funding side, we're talking about equity funding for banks, an amazing idea in banking that you would actually need any of it. And guess what they live like no corporation lives, and no corporation needs to live. But they're there because you know, I have a lot of research on leverage and leverage addiction, and it's just there at the point of such heavy indebtedness that they hate coming out.

So when people think banks need to have more capital or hold more capital, in their mind, what they hear is, well, banks just need to have more cash set aside.

So when people think banks need to have more capital or hold more capital, in their mind, what they hear is, well, banks just need to have more cash set aside.

That's what they say.

That's what they say.

But in the actual people who understand bank the idea of having more capital means that more of their funding needs to come from equity exactly.

But in the actual people who understand bank the idea of having more capital means that more of their funding needs to come from equity exactly.

So it's all about whether you get your money by promising to pay back or not and your equity investors. I mean, I come from Silicon Valley, so you know who needs to borrow to have a thriving business. Lots of companies don't pay dividends, just grow and grow and grow and market value. And you know you don't need to borrow as much. And in banking, if you just say, hey, why don't you do something good with your earnings, such as you know, make loans instead, they're I want to take the money out, and they will threaten not to make a loan in the ridiculous campaign they're making right now about this buzzle endgame, where in fact, what they're displaying, and I like to talk about it that way, is every single symptom of extraordinary overhang or even insolvency at all times. In other words, these are the classic zombie symptoms that in another sector would lead you to a fraudulent conveyance in bankruptcy or something. You know that you're taking the money out, that you're always taking a risk.

So it's all about whether you get your money by promising to pay back or not and your equity investors. I mean, I come from Silicon Valley, so you know who needs to borrow to have a thriving business. Lots of companies don't pay dividends, just grow and grow and grow and market value. And you know you don't need to borrow as much. And in banking, if you just say, hey, why don't you do something good with your earnings, such as you know, make loans instead, they're I want to take the money out, and they will threaten not to make a loan in the ridiculous campaign they're making right now about this buzzle endgame, where in fact, what they're displaying, and I like to talk about it that way, is every single symptom of extraordinary overhang or even insolvency at all times. In other words, these are the classic zombie symptoms that in another sector would lead you to a fraudulent conveyance in bankruptcy or something. You know that you're taking the money out, that you're always taking a risk.

Maybe that's a good point to back up a little bit and talk about how you understand the banking business, because a lot of people will hear a statement like, oh, banks should hold more equity, they should have less leverage, and they would think, well, that's what a bank is. You borrow and then you leverage a business. Right, it's a leverage business. So like, what exactly are we talking about if it doesn't look like that.

Maybe that's a good point to back up a little bit and talk about how you understand the banking business, because a lot of people will hear a statement like, oh, banks should hold more equity, they should have less leverage, and they would think, well, that's what a bank is. You borrow and then you leverage a business. Right, it's a leverage business. So like, what exactly are we talking about if it doesn't look like that.

Okay, So banks are leverage business in the sense if we start from the basics that deposits put them in a leverage position right away. So by the time you take the positis, if we're talking about the posit taking banks, they already start with that, unlike a company, like in a corporate finance course, where we stuck with their own equity firm as a kind of a starting point where you're kind of investing your own money or your own shareholders money. So now you're already in an area in which the people managing the bank, so the extent or not, depositors are immediately conflicted with depositors over how much equity they would have, how much risk they would take. Because of the fact that the positors, ultimately if the bank defaults or if the bank goes into resolution or whatever, you know, they might get paid or not, but the bank walked away with the upside in any case. So from that point on, the banks hate equity. The bank er hates equity. So any leveraged equity holder has a resistance to leverage reduction. That's a pervasive phenomenon. And in fact, if you let them adjust leverage just once, it's not like we go to an optimal capital structure. Always up, always up. So that's the addictiveness of boring. Now, what's the business of bank There isn't a basic conservation in the world. It's not an irrelevancy. It's not that it's irrelevant, it's just relevant in different ways to society and to the banker. The banker hates equity. From their perspective, any bit of it, you know, is too much. From society's perspective, having a huge more equity funding is only good and not bad. And in fifteen years of asking the question, why are we even here? Why do they have single digit you know, depending on all their risk or its, we can get into that. Why are we here? You know, they didn't in the history of banking, and certainly relative to other corporations that are not regulated for leverage. Even though we subsidize that in the tax code, you don't see corporations like that. How do they ever get away with that? Oh? How they get away with it is the safety nets all these bailouts all the time and place it an explicity. And that's really it, because the conservation physics of finance that I'm talking about, of physics of money is there is risk to be born and taxes to be paid, and if you bear less of it, somebody else bears more of it. If you pay less of it, somebody else pays more of it. So the whole thing we're talking about is whether banks are subsidized to be leveraged, not just want to be leveraged, but encouraged to be leveraged by the system of taxes and subsidence. And therefore they're telling us that they should be getting all these subsidies blanket to their funding and then they'll do something good with it.

Okay, So banks are leverage business in the sense if we start from the basics that deposits put them in a leverage position right away. So by the time you take the positis, if we're talking about the posit taking banks, they already start with that, unlike a company, like in a corporate finance course, where we stuck with their own equity firm as a kind of a starting point where you're kind of investing your own money or your own shareholders money. So now you're already in an area in which the people managing the bank, so the extent or not, depositors are immediately conflicted with depositors over how much equity they would have, how much risk they would take. Because of the fact that the positors, ultimately if the bank defaults or if the bank goes into resolution or whatever, you know, they might get paid or not, but the bank walked away with the upside in any case. So from that point on, the banks hate equity. The bank er hates equity. So any leveraged equity holder has a resistance to leverage reduction. That's a pervasive phenomenon. And in fact, if you let them adjust leverage just once, it's not like we go to an optimal capital structure. Always up, always up. So that's the addictiveness of boring. Now, what's the business of bank There isn't a basic conservation in the world. It's not an irrelevancy. It's not that it's irrelevant, it's just relevant in different ways to society and to the banker. The banker hates equity. From their perspective, any bit of it, you know, is too much. From society's perspective, having a huge more equity funding is only good and not bad. And in fifteen years of asking the question, why are we even here? Why do they have single digit you know, depending on all their risk or its, we can get into that. Why are we here? You know, they didn't in the history of banking, and certainly relative to other corporations that are not regulated for leverage. Even though we subsidize that in the tax code, you don't see corporations like that. How do they ever get away with that? Oh? How they get away with it is the safety nets all these bailouts all the time and place it an explicity. And that's really it, because the conservation physics of finance that I'm talking about, of physics of money is there is risk to be born and taxes to be paid, and if you bear less of it, somebody else bears more of it. If you pay less of it, somebody else pays more of it. So the whole thing we're talking about is whether banks are subsidized to be leveraged, not just want to be leveraged, but encouraged to be leveraged by the system of taxes and subsidence. And therefore they're telling us that they should be getting all these subsidies blanket to their funding and then they'll do something good with it.

So sometimes bailouts are explicit, like such as what we saw in two and eight, two thousand and nine with TARP and various programs. Sometimes I guess they're sort of implicit or the idea that well, we just sort of expect that something like that will come. What else, other than what we call bailouts, you say, through taxes, et cetera. What else encourages the demand for further leverage or the prioritization of debt financing versus equity financing.

So sometimes bailouts are explicit, like such as what we saw in two and eight, two thousand and nine with TARP and various programs. Sometimes I guess they're sort of implicit or the idea that well, we just sort of expect that something like that will come. What else, other than what we call bailouts, you say, through taxes, et cetera. What else encourages the demand for further leverage or the prioritization of debt financing versus equity financing.

It's the compensation of the bankers. It's any this fixation with return on equity, which is only return on the upside, because on the downslide, when you have less leverage, you're protected, you're less negative. So if your actual realize returns are below your funding costs.

It's the compensation of the bankers. It's any this fixation with return on equity, which is only return on the upside, because on the downslide, when you have less leverage, you're protected, you're less negative. So if your actual realize returns are below your funding costs.

Where does the fixation of return on equity come from?

Where does the fixation of return on equity come from?

That? You know, I think that it's a proxy for subsidies. I think it basically means that if you compensate somebody based on return on equity metrics where you know it's always on the upside where its juices up returns, then by doing that, by going after the return on equity, they are basically doing what you know, maybe sharelders one to some extent, but certainly works well for the bankers, which is to maximize the subsidy, to maximize the leverage, because through the leverage you get more subsidies. That's part of that. The bailouts, by the way, is a really complicated system, and you even touched on the flobs on the federal home loan banks. It's basically an interlocking set of institutions that are either providing guarantees or investing lending. So it's either the central banks that would make these excessive loans that we should get into the bank lending programs and at the same time, you know, giving for a while higher interest on reserves, which is crazy, as well as the FDIC, which has started guaranteeing all deposits with extraordinarly dangerous situation and sometimes guaranteeing other debt. After the financial crisis, they let even newly created bank holding companies that were investment banks the previous day, like Goldman Sachs and Morgan Stanley guarantees on all debt. Now, of course they could go and raise money from investors guaranteed by the FDIC, which they can do cheaply, no strings attached, and return the top money the Treasury gave them with tiny bit of strengths attached. So it's basically a system between the FED, the FDIC and Treasury and fhlbs where there are sort of investments made in the so basically the prevention of default, that's a bailout. The third party comes in. You made a promise and somebody comes in and swoops in and prevents your default.

That? You know, I think that it's a proxy for subsidies. I think it basically means that if you compensate somebody based on return on equity metrics where you know it's always on the upside where its juices up returns, then by doing that, by going after the return on equity, they are basically doing what you know, maybe sharelders one to some extent, but certainly works well for the bankers, which is to maximize the subsidy, to maximize the leverage, because through the leverage you get more subsidies. That's part of that. The bailouts, by the way, is a really complicated system, and you even touched on the flobs on the federal home loan banks. It's basically an interlocking set of institutions that are either providing guarantees or investing lending. So it's either the central banks that would make these excessive loans that we should get into the bank lending programs and at the same time, you know, giving for a while higher interest on reserves, which is crazy, as well as the FDIC, which has started guaranteeing all deposits with extraordinarly dangerous situation and sometimes guaranteeing other debt. After the financial crisis, they let even newly created bank holding companies that were investment banks the previous day, like Goldman Sachs and Morgan Stanley guarantees on all debt. Now, of course they could go and raise money from investors guaranteed by the FDIC, which they can do cheaply, no strings attached, and return the top money the Treasury gave them with tiny bit of strengths attached. So it's basically a system between the FED, the FDIC and Treasury and fhlbs where there are sort of investments made in the so basically the prevention of default, that's a bailout. The third party comes in. You made a promise and somebody comes in and swoops in and prevents your default.

I want to talk a little bit more specifically about the events of last year, because I think they're a good prism to view some of the things you were talking about through. But one of the interesting things is Silicon Valley Bank got in trouble. I don't want to say for doing the right thing, but they did go out into the market and say we're raising equity, and as you put it, you know, there's a reason why banks typically don't like to do that.

I want to talk a little bit more specifically about the events of last year, because I think they're a good prism to view some of the things you were talking about through. But one of the interesting things is Silicon Valley Bank got in trouble. I don't want to say for doing the right thing, but they did go out into the market and say we're raising equity, and as you put it, you know, there's a reason why banks typically don't like to do that.

So this is a great question, and it's a great way in fact to see what I'm saying. So what happens is they have definitions these days in the regulatory community of what a well capitalized bank is. It just so happened that both in the financial crisis and last spring and now banks are considered well capitalized by a lot of the banks that failed, including First Republic, got great camel ratings just before they failed, so they can say it's well capitalized. Now, why is that because the metrics are so bad, and the metrics include not recognizing fair market value on hultimaturity assets. So the bank is pretending to have these assets that they bought at power value even though they're losing value like treasuries. In addition, capital ratios depend on risk weights, and the risk weights ignore interest rate risk entirely, only credit risk. So a treasury needs no equity backing. So even if you buy you buy a treasury and you can do it, and one hundred percent of deposit money, well, the treasury can lose in value. What happened in Silicon Valley Bank was the following in banking in general. You know, being a zombie, being insolvent is Monday morning, Okay. What they're showing is symptoms to a corporate doctor like myself is every day, the symptoms of the more they hate equity with the passion they hate equity, the more things they have way too little of it. So that's that. Now, what happened in Silicon Valley Bank two things. First of all, they had to sell some assets, so this whole two maturity might not actually work out for you, and the assets are worth less as you have to pay more on deposits. The assets are worth less because their long term have big duration risks, and interest rates went down, so when they sold, they had to realize the losses. Sudden accounting rules that usually can allow you to hide the losses are forcing you to recognize the losses. So that was the first thing. Then basically, how would they survive. They were beginning to be more obviously more visibly insolvent. So the next thing that happens is they try to raise equity, as you said, and they couldn't. Now, if you can raise equity, if somebody not at the price you like, but at the price a penny a dime for your equity, then you might still be insolvent because there's only the upside. It's just an option on the upside because you can always walk away as equity. But if you cannot raise equity, then you're really deep in the water. So they're not raising equities like the ultimate nail in the coffin. In other words, you're definitely sold. At that point, the run was unavoidable because you know, of course, maybe by now that they've guaranteed effectively everything, maybe people won't run. And maybe we consider that kicking the can down the road as a good financial stability measures. But that is extraordinary dangerous because in the eighties we allowed all these zombie savings and loans to persist and raise money guaranteed by the taxpayers until you know, we have to pay for it.

So this is a great question, and it's a great way in fact to see what I'm saying. So what happens is they have definitions these days in the regulatory community of what a well capitalized bank is. It just so happened that both in the financial crisis and last spring and now banks are considered well capitalized by a lot of the banks that failed, including First Republic, got great camel ratings just before they failed, so they can say it's well capitalized. Now, why is that because the metrics are so bad, and the metrics include not recognizing fair market value on hultimaturity assets. So the bank is pretending to have these assets that they bought at power value even though they're losing value like treasuries. In addition, capital ratios depend on risk weights, and the risk weights ignore interest rate risk entirely, only credit risk. So a treasury needs no equity backing. So even if you buy you buy a treasury and you can do it, and one hundred percent of deposit money, well, the treasury can lose in value. What happened in Silicon Valley Bank was the following in banking in general. You know, being a zombie, being insolvent is Monday morning, Okay. What they're showing is symptoms to a corporate doctor like myself is every day, the symptoms of the more they hate equity with the passion they hate equity, the more things they have way too little of it. So that's that. Now, what happened in Silicon Valley Bank two things. First of all, they had to sell some assets, so this whole two maturity might not actually work out for you, and the assets are worth less as you have to pay more on deposits. The assets are worth less because their long term have big duration risks, and interest rates went down, so when they sold, they had to realize the losses. Sudden accounting rules that usually can allow you to hide the losses are forcing you to recognize the losses. So that was the first thing. Then basically, how would they survive. They were beginning to be more obviously more visibly insolvent. So the next thing that happens is they try to raise equity, as you said, and they couldn't. Now, if you can raise equity, if somebody not at the price you like, but at the price a penny a dime for your equity, then you might still be insolvent because there's only the upside. It's just an option on the upside because you can always walk away as equity. But if you cannot raise equity, then you're really deep in the water. So they're not raising equities like the ultimate nail in the coffin. In other words, you're definitely sold. At that point, the run was unavoidable because you know, of course, maybe by now that they've guaranteed effectively everything, maybe people won't run. And maybe we consider that kicking the can down the road as a good financial stability measures. But that is extraordinary dangerous because in the eighties we allowed all these zombie savings and loans to persist and raise money guaranteed by the taxpayers until you know, we have to pay for it.

One of the arguments obviously against higher capital ratios or more equity is like, oh, this will be lead to an austerity of credit, that banks won't be able to do lending. And this is a big part of the push again to some of these rules that there's going to be less lending, etcetera. Why is that wrong? Interview?

One of the arguments obviously against higher capital ratios or more equity is like, oh, this will be lead to an austerity of credit, that banks won't be able to do lending. And this is a big part of the push again to some of these rules that there's going to be less lending, etcetera. Why is that wrong? Interview?

Well, first of all, they can make any loan. My first measure and my first emergency measure since the financial crisis, and you know I said this with twenty academics and lots of people is to retain them earnings and use them for loans. So what's the problem now? So I've been asking for fifteen years, tell me again what would go wrong if they retain their earnings? Just go take me through an argument and economic argument of how the economy would suffer. In other words, is their subsidies so big that God forbid, you know, they'll die? You know, if they'll die, you know, or they can't survive. I question their business model. If the busy, if the entire charter value that you like to talk about subsidies, then we have to question the business model. Just you started by saying, so my point is the following. If you tell them not a ratio, Actually I am against giving them ratios from where we are right now. You take them by the hand through issuance and retentions, because then they won't shrink inefficiently. Because a paper I wrote called leverg Bratchet actually shows the ways of deleveraging, and we show that there is a tendency to level as it saves or stopping to lend or whatever to through shrinkage versus expansion. Well, I will expand. These are monstrous banks, which I'm saying to expand only because I believe that once they live in markets, once they're in equity markets, they will break up on their own inefficient weight, because as conglomerates broke up in the AD, because we don't need such complicated institutions. I was, you know, back in doubles in twenty fourteen with Paul Singer of Everybody, and he says these are two opake. I cannot put my analysts on it and understand their risk. They would not exist in market as they are right now. Once you push them more and more into equity markets, it's equity marketer will give them the stress test. That's my stress test. My stress test is raised equity. Let's see at what price? What will investors say when they have to bear the downside?

Well, first of all, they can make any loan. My first measure and my first emergency measure since the financial crisis, and you know I said this with twenty academics and lots of people is to retain them earnings and use them for loans. So what's the problem now? So I've been asking for fifteen years, tell me again what would go wrong if they retain their earnings? Just go take me through an argument and economic argument of how the economy would suffer. In other words, is their subsidies so big that God forbid, you know, they'll die? You know, if they'll die, you know, or they can't survive. I question their business model. If the busy, if the entire charter value that you like to talk about subsidies, then we have to question the business model. Just you started by saying, so my point is the following. If you tell them not a ratio, Actually I am against giving them ratios from where we are right now. You take them by the hand through issuance and retentions, because then they won't shrink inefficiently. Because a paper I wrote called leverg Bratchet actually shows the ways of deleveraging, and we show that there is a tendency to level as it saves or stopping to lend or whatever to through shrinkage versus expansion. Well, I will expand. These are monstrous banks, which I'm saying to expand only because I believe that once they live in markets, once they're in equity markets, they will break up on their own inefficient weight, because as conglomerates broke up in the AD, because we don't need such complicated institutions. I was, you know, back in doubles in twenty fourteen with Paul Singer of Everybody, and he says these are two opake. I cannot put my analysts on it and understand their risk. They would not exist in market as they are right now. Once you push them more and more into equity markets, it's equity marketer will give them the stress test. That's my stress test. My stress test is raised equity. Let's see at what price? What will investors say when they have to bear the downside?

Is?

Is?

Where is the upside? If you don't like that price, maybe that's telling us something.

Where is the upside? If you don't like that price, maybe that's telling us something.

Since you mentioned twenty fourteen, I think that was the year when there was a New York Times profile about you, and I cannot remember the exact headline, but why is it in?

Since you mentioned twenty fourteen, I think that was the year when there was a New York Times profile about you, and I cannot remember the exact headline, but why is it in?

This said? The whole story behind it, which I won't tell you all of it, but it was by ben in Minneapplebaum, who used to be a feder reporter who I first met when he was a federal reporter, and I won't go through all the details, but when he ended up writing the profile, it was entitled when she talks banks shutter Yeah, and what I say, So, I've asked a few times about that with people who've noticed the headline, and I say, oh, Jamie Damon slips like a baby. In other words, the headline is cute but false.

This said? The whole story behind it, which I won't tell you all of it, but it was by ben in Minneapplebaum, who used to be a feder reporter who I first met when he was a federal reporter, and I won't go through all the details, but when he ended up writing the profile, it was entitled when she talks banks shutter Yeah, and what I say, So, I've asked a few times about that with people who've noticed the headline, and I say, oh, Jamie Damon slips like a baby. In other words, the headline is cute but false.

But this leads into something I wanted to ask you. And I'm trying to think how to phrase this question without sounding hokey. But you know, you've been criticizing the banks and the regulators, models.

But this leads into something I wanted to ask you. And I'm trying to think how to phrase this question without sounding hokey. But you know, you've been criticizing the banks and the regulators, models.

And the regulators, especially for the banks do what they get away with.

And the regulators, especially for the banks do what they get away with.

Yeah, for decades now, basically, and I guess it I have yet what motivates you to do this?

Yeah, for decades now, basically, and I guess it I have yet what motivates you to do this?

Oh? Good, Such a good question because I often wonder that myself. Okay, so what motivated me in the beginning was you know, I sort of fell in a rabbit hole when I started looking into banking. I'm not just a corporate finance corporate governance person. And I look at those corporations which I was teaching my students for you know, twenty five years, what a wonderful market we have, and all of a sudden that market like what just happened? And then I look at them and I say, okay, I understand about corporations. We don't talk specifically about banks because that's something some other silo in economics, but if I look at them as a corporate finance person, and I say, what's the same and what's different about them, And all of a sudden, what's different about them is all bad. And what's different about them is what they get away with more than anything, you know, the specialness of banks is literally what they get away with. And then the politics of banking, that's what's special. And then I all of a sudden realized, you know, if nobody understands what the word means, if the regulators are standing by, if the politicians want banks to make some loans or some campaign donations or whatever else, and nobody is exposing the nonsense that we have in this space that pervades this space, that maintains and enables this to continue. So I was basically alarmed by people inside the FED that terrible things are happening in Basil when they were negotiating that agreement. And I was encouraged by people both inside some places in the FED and in the Bank of England at the time where I had most of my friends at the time when Mervin King was there, to get involved. And I truly didn't know what I was getting into when I agreed to do this. I was joking that I'm working for and the hell dying, you know, that kind of thing. So he was at the Bank of England at the time, and so was Mervin King, who gave us a blurb for the book, and while the governor of the bank. So there were big, fierce battles at the time post financial crisis about the topic, and I felt and I mobilized a lot of academics to help me, but it was very difficult work. You were at Financial Times at the time, Tracy, and getting through even the opinion pages against bankers is impossible, and that's the opinion pages now in the politics like forget it. So I began to really see the politics something I was not aware is so important in finance and how much it plays in banking. So I stayed in this debate just basically hating to be worn out more than anything, just not wanting for them, with the resources that they have, with the amount of lobbying and the amount of money that they spend across the political system and the regulation system and global institutions and all that, to kind of give up because I felt a sense of duty basically to society that I actually know something that's useful and it's my job to say. But anyway, I worked on it for five six years, and then I essentially wrote a few essays that were kind of putting it to bed around twenty fifteen sixteen, and that I'm back here is kind of almost didn't happen. It was a decade since the book was published.

Oh? Good, Such a good question because I often wonder that myself. Okay, so what motivated me in the beginning was you know, I sort of fell in a rabbit hole when I started looking into banking. I'm not just a corporate finance corporate governance person. And I look at those corporations which I was teaching my students for you know, twenty five years, what a wonderful market we have, and all of a sudden that market like what just happened? And then I look at them and I say, okay, I understand about corporations. We don't talk specifically about banks because that's something some other silo in economics, but if I look at them as a corporate finance person, and I say, what's the same and what's different about them, And all of a sudden, what's different about them is all bad. And what's different about them is what they get away with more than anything, you know, the specialness of banks is literally what they get away with. And then the politics of banking, that's what's special. And then I all of a sudden realized, you know, if nobody understands what the word means, if the regulators are standing by, if the politicians want banks to make some loans or some campaign donations or whatever else, and nobody is exposing the nonsense that we have in this space that pervades this space, that maintains and enables this to continue. So I was basically alarmed by people inside the FED that terrible things are happening in Basil when they were negotiating that agreement. And I was encouraged by people both inside some places in the FED and in the Bank of England at the time where I had most of my friends at the time when Mervin King was there, to get involved. And I truly didn't know what I was getting into when I agreed to do this. I was joking that I'm working for and the hell dying, you know, that kind of thing. So he was at the Bank of England at the time, and so was Mervin King, who gave us a blurb for the book, and while the governor of the bank. So there were big, fierce battles at the time post financial crisis about the topic, and I felt and I mobilized a lot of academics to help me, but it was very difficult work. You were at Financial Times at the time, Tracy, and getting through even the opinion pages against bankers is impossible, and that's the opinion pages now in the politics like forget it. So I began to really see the politics something I was not aware is so important in finance and how much it plays in banking. So I stayed in this debate just basically hating to be worn out more than anything, just not wanting for them, with the resources that they have, with the amount of lobbying and the amount of money that they spend across the political system and the regulation system and global institutions and all that, to kind of give up because I felt a sense of duty basically to society that I actually know something that's useful and it's my job to say. But anyway, I worked on it for five six years, and then I essentially wrote a few essays that were kind of putting it to bed around twenty fifteen sixteen, and that I'm back here is kind of almost didn't happen. It was a decade since the book was published.

This book, the book, by the way, I should have said in the intro, it's the Banker's New Clothes, and you have a new edition coming up exactly.

This book, the book, by the way, I should have said in the intro, it's the Banker's New Clothes, and you have a new edition coming up exactly.

So the book edition just came out in January in the US, and the book got fat because of because we had to vamp a lot of stuff and take a lot of stuff out of the editing floor to explain more about central banks. So there are a few expansions of the material. The book is called The Banker's New Clothes. Was wrong with banking to do about it? The Banker's New Clothes refers to flood claims. So that's the list of which we now have forty four. But somebody just pointed me out to an add that was apparently in the football games, saying that grocery prices will go up and their mother won't be able to buy lollipop if you increase capital requirements.

So the book edition just came out in January in the US, and the book got fat because of because we had to vamp a lot of stuff and take a lot of stuff out of the editing floor to explain more about central banks. So there are a few expansions of the material. The book is called The Banker's New Clothes. Was wrong with banking to do about it? The Banker's New Clothes refers to flood claims. So that's the list of which we now have forty four. But somebody just pointed me out to an add that was apparently in the football games, saying that grocery prices will go up and their mother won't be able to buy lollipop if you increase capital requirements.

So I take it just an increase in capital requirement is probably in your view, necessary but not sufficient to a stable financy.

So I take it just an increase in capital requirement is probably in your view, necessary but not sufficient to a stable financy.

It is the most no brainer thing.

It is the most no brainer thing.

But what is an actual you know, we sort of tease Tracy said in the beginning, well, could we ever have a world where we don't have to have bailouts? And I'm kind of skeptical that that'll have? What would what would it take? Or what is the what is the basics of your prescription?

But what is an actual you know, we sort of tease Tracy said in the beginning, well, could we ever have a world where we don't have to have bailouts? And I'm kind of skeptical that that'll have? What would what would it take? Or what is the what is the basics of your prescription?

So the basics of our prescriptions and we go through them extensively in the book. What to aim for, What to watch for as you do this, you know, is basically to maintain to aim at equity ratios that fluctuate between twenty and thirty percent of total assets. It's important because the risk weights are really the ones that reduce their assets by like a half or more in our gamed continuously and actually add to fragility because you give zero weight to government bond, you give zero risk wed it. They're actually anti lending the risk weights themselves. So that's a whole other can of worms. But we're against the risk weights, except maybe as a backup right now, it's the leverage ratio that is a three percent or maybe five percent ridiculous numbers that are missing a digit is we're not there, We're not close to where we need to be. And if people say the industry will shrink, I say, fine, that's maybe a feature not a bug. In other words, maybe the industry is two bloaded and two big.

So the basics of our prescriptions and we go through them extensively in the book. What to aim for, What to watch for as you do this, you know, is basically to maintain to aim at equity ratios that fluctuate between twenty and thirty percent of total assets. It's important because the risk weights are really the ones that reduce their assets by like a half or more in our gamed continuously and actually add to fragility because you give zero weight to government bond, you give zero risk wed it. They're actually anti lending the risk weights themselves. So that's a whole other can of worms. But we're against the risk weights, except maybe as a backup right now, it's the leverage ratio that is a three percent or maybe five percent ridiculous numbers that are missing a digit is we're not there, We're not close to where we need to be. And if people say the industry will shrink, I say, fine, that's maybe a feature not a bug. In other words, maybe the industry is two bloaded and two big.

I mean, we talk about it on the show all the time. What if it's not a matter of the industry shrinking but migrating to what people call shadow Okay.

I mean, we talk about it on the show all the time. What if it's not a matter of the industry shrinking but migrating to what people call shadow Okay.

And the forty four flood claims, all of it is there. You'll find the grab bag of them that they use. So what sort of not just people a little bit is the fact that all along two things are true about the shadow banking system. Number One, institutions in the shadow bankings that are not connected as much to the or not as obviously to the safety net to those bailout system actually fund with more equity. That was true for reads, and that was true for like thirty percent is common sometimes. And then now one colleague and a few other people have a paper about mortgage lenders which have to disclose some things in some states, and they analyze it and they show that lenders for mortgages that are not in the banking sector and are not regulated like banks have twice as much equity as the banks, So what's the problem lending with money that's raised however in markets? So and then the second point about shadow banking is most of the time, I mean, the ultimately the first incarnation of a shadow bank is money market fund right, So what ends up happening with shadow banking is most of it if you follow the money, is connected funded by et cetera, the banks in the end, So when you follow the money, you'll find the safety net someplace along the way. So money market funds are just creating another leg of intermediation. And then they can run on the banks, their investors can run on them, and then we couldn't you know, we opened up this bigot on them in COVID again because their reforms didn't work.

And the forty four flood claims, all of it is there. You'll find the grab bag of them that they use. So what sort of not just people a little bit is the fact that all along two things are true about the shadow banking system. Number One, institutions in the shadow bankings that are not connected as much to the or not as obviously to the safety net to those bailout system actually fund with more equity. That was true for reads, and that was true for like thirty percent is common sometimes. And then now one colleague and a few other people have a paper about mortgage lenders which have to disclose some things in some states, and they analyze it and they show that lenders for mortgages that are not in the banking sector and are not regulated like banks have twice as much equity as the banks, So what's the problem lending with money that's raised however in markets? So and then the second point about shadow banking is most of the time, I mean, the ultimately the first incarnation of a shadow bank is money market fund right, So what ends up happening with shadow banking is most of it if you follow the money, is connected funded by et cetera, the banks in the end, So when you follow the money, you'll find the safety net someplace along the way. So money market funds are just creating another leg of intermediation. And then they can run on the banks, their investors can run on them, and then we couldn't you know, we opened up this bigot on them in COVID again because their reforms didn't work.

You mentioned the initial round of Basil rules sort of posts two thousand and eight, and of course you've already touched on this as well. But we do have another effort, the Basil endgame proposal. Now, when we talked to Steve Kelly about this, he was like, well, why even bother talking about it, because like, for sure it's going to change from its current proposed form, but maybe with that caveat, can you talk a little bit about whether you think that's a useful revision of the rules.

You mentioned the initial round of Basil rules sort of posts two thousand and eight, and of course you've already touched on this as well. But we do have another effort, the Basil endgame proposal. Now, when we talked to Steve Kelly about this, he was like, well, why even bother talking about it, because like, for sure it's going to change from its current proposed form, but maybe with that caveat, can you talk a little bit about whether you think that's a useful revision of the rules.

Well, I signed two comment letters on basil endgame and one on the long term debt proposal, which also kind of triggered me a lot. And I signed one letter by thirty academics who are kind of you know, friends of the FED supporting it, saying it's a step in the right the right And then in my own letter on it, to which I attached the previous version of these forty four flood claims and other writings and testimonies from the last fifteen years, I said, well, you know, I hope it's not endgame, because we will come back to it after another financial crisis, if not a bigger you know, it has to be very spectacular because obviously the last one didn't you know, affect it enough. In other words, it's really depressing how they always have these liquidity narratives and other things and focus on bailouts again instead of actually going and you know, DoD Frank said no more bailouts, and there's plenty of authority to do anything, certainly to do even a lot more here both the provision, which completely failed in this case, and on the target numbers and on making them more meaningful, because they're still not meaningful. So why are we talking about it? I would say, yes, these are kind of useless. Are they good? It depends how you enforce them. All of these rules end up not you know, if you look just at the radar that shows you these issues, you won't even know there was a financial crisis. The banks that needed the most bailout looked good all through the crisis, you know. And that's a study that was also done after the crisis. So the bottom line is, we don't like the metrics, we don't like the numbers, the range of numbers. And so I'm coming at it from completely the other side. I'm saying this continues to be poorly designed and inadequate. And in addition to this, I am not a hawk or other regulations. It's just this one is just correcting a huge distortion. It's only on the funding side. It's liquidity regulations that put money on the sidelines. It's the liquidity regulations that are costly in good times and useless in Iran, you know. So that's the problem. So a lot of living wills, complicated risk weits, stress tests like ever my stress test market stress test. So I'm totally into just bringing the funding into markets, and especially into equity markets. Start with that and the rest might look a little bit better.

Well, I signed two comment letters on basil endgame and one on the long term debt proposal, which also kind of triggered me a lot. And I signed one letter by thirty academics who are kind of you know, friends of the FED supporting it, saying it's a step in the right the right And then in my own letter on it, to which I attached the previous version of these forty four flood claims and other writings and testimonies from the last fifteen years, I said, well, you know, I hope it's not endgame, because we will come back to it after another financial crisis, if not a bigger you know, it has to be very spectacular because obviously the last one didn't you know, affect it enough. In other words, it's really depressing how they always have these liquidity narratives and other things and focus on bailouts again instead of actually going and you know, DoD Frank said no more bailouts, and there's plenty of authority to do anything, certainly to do even a lot more here both the provision, which completely failed in this case, and on the target numbers and on making them more meaningful, because they're still not meaningful. So why are we talking about it? I would say, yes, these are kind of useless. Are they good? It depends how you enforce them. All of these rules end up not you know, if you look just at the radar that shows you these issues, you won't even know there was a financial crisis. The banks that needed the most bailout looked good all through the crisis, you know. And that's a study that was also done after the crisis. So the bottom line is, we don't like the metrics, we don't like the numbers, the range of numbers. And so I'm coming at it from completely the other side. I'm saying this continues to be poorly designed and inadequate. And in addition to this, I am not a hawk or other regulations. It's just this one is just correcting a huge distortion. It's only on the funding side. It's liquidity regulations that put money on the sidelines. It's the liquidity regulations that are costly in good times and useless in Iran, you know. So that's the problem. So a lot of living wills, complicated risk weits, stress tests like ever my stress test market stress test. So I'm totally into just bringing the funding into markets, and especially into equity markets. Start with that and the rest might look a little bit better.

So one of the things that comes up when talking about the endgame proposal is the idea of you know, well, poor Michael Barr needs to build consensus. He has to talk to all these different stakeholders about like very technical and complicated things. Can you give us a little bit of color on your experience about how new banking rules actually come into being. I'm always curious.

So one of the things that comes up when talking about the endgame proposal is the idea of you know, well, poor Michael Barr needs to build consensus. He has to talk to all these different stakeholders about like very technical and complicated things. Can you give us a little bit of color on your experience about how new banking rules actually come into being. I'm always curious.

Oh, you know, the sausage making is amazing. So I was actually in DC and I met a few of the regulars, including Mike Barr. I think it's on his official calendar, so I can tell you that. And yes, and everybody was feeling very sorry for Michael Barr. I of course was feeling frustrated that he, you know, didn't speak more strongly. His first speech was okay, but afterwards, oh, we'll change it, will change it whatever. So anyway, I mean, I told him this to his face, you know, and offered my help to argue against all these flood claims. There's a manual of how to respond to all these. So here's the interesting things for monitory policy. The FED Board is always unanimous. Like you know, when Kevin Warsh objected to QAES, he basically had to leave. Honig would object from the Regional Reserve Bank on monitoring on regulation, they don't have to be consensus, so he needs four out of seven. And you know, some of the support was tentative. Some of the statements that the governors made were full of flood claims, and I didn't get a chance to meet all of them, but I would welcome that. So I just think there's a great confusion and a lot of politics and sort of ways of thinking and banking that are very entrenched, and so I don't know. I think you know, what this proposal ultimately is doing is not changing the top head numbers, but tweaking risk. Weits a little bit. And by increasing the risk, wait a little bit, that's a little bit or equity you have to have against a particular edset out of millions. Never mind that they don't take care of correlations and interest rate risk and other things, but just on the credit risk part. And so the banks are weaponizing this extremely disingenuously to make threats that you and you and you and you won't make it loan, which, of course, once they get the cheap funding, they'll do what they'll do, they'll maximize our e whatever. So the politics of it is really ugly. When I was in DC a couple of weeks ago, it was oozing from everywhere. The bombardment of lobbying was really shocking. It was never in the popular you know, on billboards and ads on your podcast. I mean, you know, I heard the ads on your podcast, Stop Basile Endgame. They have explainers on that website that are wrong. You know, students coming into my course just out of the corporate finance course, it's like you're saying that equity is expensive because it's risky. What's wrong with all these companies that have plenty of equity and I don't choose to borrow even though there's no regulation. What are you talking about? This is absolute bread and butter finance. Leverage and risk risk and return required return is completely bread and butter. And so that's when you're even in the right side of the balance sheet and not on the cash reserve thing. It's crazy stuff.

Oh, you know, the sausage making is amazing. So I was actually in DC and I met a few of the regulars, including Mike Barr. I think it's on his official calendar, so I can tell you that. And yes, and everybody was feeling very sorry for Michael Barr. I of course was feeling frustrated that he, you know, didn't speak more strongly. His first speech was okay, but afterwards, oh, we'll change it, will change it whatever. So anyway, I mean, I told him this to his face, you know, and offered my help to argue against all these flood claims. There's a manual of how to respond to all these. So here's the interesting things for monitory policy. The FED Board is always unanimous. Like you know, when Kevin Warsh objected to QAES, he basically had to leave. Honig would object from the Regional Reserve Bank on monitoring on regulation, they don't have to be consensus, so he needs four out of seven. And you know, some of the support was tentative. Some of the statements that the governors made were full of flood claims, and I didn't get a chance to meet all of them, but I would welcome that. So I just think there's a great confusion and a lot of politics and sort of ways of thinking and banking that are very entrenched, and so I don't know. I think you know, what this proposal ultimately is doing is not changing the top head numbers, but tweaking risk. Weits a little bit. And by increasing the risk, wait a little bit, that's a little bit or equity you have to have against a particular edset out of millions. Never mind that they don't take care of correlations and interest rate risk and other things, but just on the credit risk part. And so the banks are weaponizing this extremely disingenuously to make threats that you and you and you and you won't make it loan, which, of course, once they get the cheap funding, they'll do what they'll do, they'll maximize our e whatever. So the politics of it is really ugly. When I was in DC a couple of weeks ago, it was oozing from everywhere. The bombardment of lobbying was really shocking. It was never in the popular you know, on billboards and ads on your podcast. I mean, you know, I heard the ads on your podcast, Stop Basile Endgame. They have explainers on that website that are wrong. You know, students coming into my course just out of the corporate finance course, it's like you're saying that equity is expensive because it's risky. What's wrong with all these companies that have plenty of equity and I don't choose to borrow even though there's no regulation. What are you talking about? This is absolute bread and butter finance. Leverage and risk risk and return required return is completely bread and butter. And so that's when you're even in the right side of the balance sheet and not on the cash reserve thing. It's crazy stuff.

So we could say, okay, banks could be safer in a world in which they're much more equity finance. What about coming from the perspective of creditors to the bank. So there's certain capital that exists in the world that seeks out bank ponds, insurance companies, pensions, things like that may have a lot of demand for bank credit assets. Where does that money go in different world?

So we could say, okay, banks could be safer in a world in which they're much more equity finance. What about coming from the perspective of creditors to the bank. So there's certain capital that exists in the world that seeks out bank ponds, insurance companies, pensions, things like that may have a lot of demand for bank credit assets. Where does that money go in different world?

So are you talking now about the people who are customers who are boring front them? Okay, great, great subject. Okay, So here's the thing. Here's what's amazing about banks, and here's the real abnormality of the bank the deposits of which, by the way, JP Morgan Chase now has two and a half trillion dollars. Okay, that is money that is a very unusual debt because it has no collateral. This is important to understand, no collateral, but has insurance, which effectively is now almost unbounded. So what happens is that the depositors are almost all the time completely passive. I mean, if they'll panic one day, but they are always just telling them not to panic and just go about their business. So they sit there. Now, once you have this funding, it's a good time. It's a good life because you can use the assets collateral for the other lenders. And the other lenders come in and they have collateral to their name short term lending, so they feel they can almost like depositors, take the money out with droid and they have safe harbor laws that in a bankruptcy they can actually walk away with a collateral. So if they including the federal home loan banks, including even if they've fed, they are safe. So in the ratcheting of leverage and in the sort of race toy. So there's another related paper saying that there's a race to shorten maturity, and then of course there's collateral races. What you have is the ability to keep shortening maturity and to keep giving collateral as a way to favor new lenders over old lenders. And the most passive lenders to take advantage of are the depositors and those who back them. So that's what actually happens in the economics of it. Your ability to ratchet up your boring and the ability of your lenders to both chase their own returns, and we can talk about you know, returns offered on cocoas and all of that which in the end wink wink not and not actually absorbing lostsses. And we didn't mention credit twists in last year's events in the spring, which happened a week or nine days after Silicon Valley Bank, and that was a spectacular event in the world of banking of big systemic institutions, that requires a lot of a whole discussion, and we might not have time for. But all the talk in the same you know a couple of years that I went to Davos about how we and have bail ins instead of bailouts and all these teal action long term debt proposal, which completely triggered me over the Martin Luther King Weiken when I was preparing these comment letters once again extraordinarily exacerbated that I even have to do this totally groundhog They they don't, they don't. As Tom Honing likes to say, why are we solving a problem of too much debt with more debt? If you have equity instead of the long term debt, instead of this title loss absorbing capacity, you would not get to that level. If Silicon Valley Bank had twenty percent equity, would absorb those losses from interest rate decreases. If credits wiss, you know, more meaningful, I'm saying, better measured equity, we wouldn't be here.

So are you talking now about the people who are customers who are boring front them? Okay, great, great subject. Okay, So here's the thing. Here's what's amazing about banks, and here's the real abnormality of the bank the deposits of which, by the way, JP Morgan Chase now has two and a half trillion dollars. Okay, that is money that is a very unusual debt because it has no collateral. This is important to understand, no collateral, but has insurance, which effectively is now almost unbounded. So what happens is that the depositors are almost all the time completely passive. I mean, if they'll panic one day, but they are always just telling them not to panic and just go about their business. So they sit there. Now, once you have this funding, it's a good time. It's a good life because you can use the assets collateral for the other lenders. And the other lenders come in and they have collateral to their name short term lending, so they feel they can almost like depositors, take the money out with droid and they have safe harbor laws that in a bankruptcy they can actually walk away with a collateral. So if they including the federal home loan banks, including even if they've fed, they are safe. So in the ratcheting of leverage and in the sort of race toy. So there's another related paper saying that there's a race to shorten maturity, and then of course there's collateral races. What you have is the ability to keep shortening maturity and to keep giving collateral as a way to favor new lenders over old lenders. And the most passive lenders to take advantage of are the depositors and those who back them. So that's what actually happens in the economics of it. Your ability to ratchet up your boring and the ability of your lenders to both chase their own returns, and we can talk about you know, returns offered on cocoas and all of that which in the end wink wink not and not actually absorbing lostsses. And we didn't mention credit twists in last year's events in the spring, which happened a week or nine days after Silicon Valley Bank, and that was a spectacular event in the world of banking of big systemic institutions, that requires a lot of a whole discussion, and we might not have time for. But all the talk in the same you know a couple of years that I went to Davos about how we and have bail ins instead of bailouts and all these teal action long term debt proposal, which completely triggered me over the Martin Luther King Weiken when I was preparing these comment letters once again extraordinarily exacerbated that I even have to do this totally groundhog They they don't, they don't. As Tom Honing likes to say, why are we solving a problem of too much debt with more debt? If you have equity instead of the long term debt, instead of this title loss absorbing capacity, you would not get to that level. If Silicon Valley Bank had twenty percent equity, would absorb those losses from interest rate decreases. If credits wiss, you know, more meaningful, I'm saying, better measured equity, we wouldn't be here.

I just remember in the first time I ever wrote about contingent capital, it was on FT alphavel and even that, you're right, there was this discussion about like whether or not it would actually get used in an emergency. But maybe just to help us understand the argument, you know, it's so hard even for me and I've been covering financials for a long time, to imagine a banking business model where they're not borrowing and lending and highly leveraged. So I want to ask, like, is.

I just remember in the first time I ever wrote about contingent capital, it was on FT alphavel and even that, you're right, there was this discussion about like whether or not it would actually get used in an emergency. But maybe just to help us understand the argument, you know, it's so hard even for me and I've been covering financials for a long time, to imagine a banking business model where they're not borrowing and lending and highly leveraged. So I want to ask, like, is.

Heaven twenty percent equity and seven seventy or eighty percent debt allows you to do all the boring and lending you need to do. Is it allows you to take all the deposits, allow you to make all the loans you make?

Heaven twenty percent equity and seven seventy or eighty percent debt allows you to do all the boring and lending you need to do. Is it allows you to take all the deposits, allow you to make all the loans you make?

I take the point, But what I want to ask is like, if you think about your ideal banking system, what does it look like. Does it exist somewhere in the world already or has it existed in the past.

I take the point, But what I want to ask is like, if you think about your ideal banking system, what does it look like. Does it exist somewhere in the world already or has it existed in the past.

Has it existed in the past. Definitely before safety in it first of all, when banks were partnerships, not even limited ability corporations. They had fifty percent equity and unlimited liability for the Jamie Diamonds the of the world. In other words, there was the all money and they had to be the ones ensuring depositors. Back in the nineteenth century. You know, the depositors won't trust them, otherwise somebody had to back it up. We go into a world in which we introduce after runs and panics and all of that, we introduce the posit insurance, we introduce its central banks for that so so equity for example, you know when they started FDAC banks in Kansas, for example, they didn't want FDS insurance and they had twenty percent equity. So in the history of banking, you know, in the start of the twentieth century banks that twenty thirty percent equity. So it's not unheard of. The equity markets are more developed. If they have a business model, there are investors who will give to them at their appropriate prices. They just don't like those prices because what they're telling equity investors is to take on risks right now on other people, including governments and taxpayers. So the point is, you know, my banking system would look a lot safer, and all the de leveraging that would happen would happen much lower. You'd have a lot more time to intervene as you see losses mountop. If you're looking, somebody should look. If it's not going to be the investors, it's going to have to be the regulators. And that's all these to it. It's not rocket science, so you know, and on on contingent capital. There has never been an argument why at the point of the you force them to issue those because they also don't like those because maybe the long term, you know, unsecuredy investors might ask a question or two about the off chance that they would lose they you know. In an interview in twenty thirteen, Stump, the SEAO of Wells Fargo, said, we have a lot of retail deposits and therefore we don't have a lot of death And I had a deposit with him, so he even forgot, Like, you can't make up the nonsense they say. So bottom line is, you know, get the equity, retain the earnings, and come back you know later.

Has it existed in the past. Definitely before safety in it first of all, when banks were partnerships, not even limited ability corporations. They had fifty percent equity and unlimited liability for the Jamie Diamonds the of the world. In other words, there was the all money and they had to be the ones ensuring depositors. Back in the nineteenth century. You know, the depositors won't trust them, otherwise somebody had to back it up. We go into a world in which we introduce after runs and panics and all of that, we introduce the posit insurance, we introduce its central banks for that so so equity for example, you know when they started FDAC banks in Kansas, for example, they didn't want FDS insurance and they had twenty percent equity. So in the history of banking, you know, in the start of the twentieth century banks that twenty thirty percent equity. So it's not unheard of. The equity markets are more developed. If they have a business model, there are investors who will give to them at their appropriate prices. They just don't like those prices because what they're telling equity investors is to take on risks right now on other people, including governments and taxpayers. So the point is, you know, my banking system would look a lot safer, and all the de leveraging that would happen would happen much lower. You'd have a lot more time to intervene as you see losses mountop. If you're looking, somebody should look. If it's not going to be the investors, it's going to have to be the regulators. And that's all these to it. It's not rocket science, so you know, and on on contingent capital. There has never been an argument why at the point of the you force them to issue those because they also don't like those because maybe the long term, you know, unsecuredy investors might ask a question or two about the off chance that they would lose they you know. In an interview in twenty thirteen, Stump, the SEAO of Wells Fargo, said, we have a lot of retail deposits and therefore we don't have a lot of death And I had a deposit with him, so he even forgot, Like, you can't make up the nonsense they say. So bottom line is, you know, get the equity, retain the earnings, and come back you know later.

All right, and not at MADI. It was so great to finally speak to you on this podcast and the new edition of the book, The Banker's New Clothes is out now, So thank you so much.

All right, and not at MADI. It was so great to finally speak to you on this podcast and the new edition of the book, The Banker's New Clothes is out now, So thank you so much.

Thank you, thank you.

Thank you, thank you.

That was great.

That was great.

It was a lot of fun. Thank you so much, Joe.

It was a lot of fun. Thank you so much, Joe.

I'm glad we did that conversation. Yeah, obviously there is still a lot more to say about banks, not just about how we bail them out, but maybe getting to that place, as a not mentioned, where they don't need to be bailed out on a regular basis.

I'm glad we did that conversation. Yeah, obviously there is still a lot more to say about banks, not just about how we bail them out, but maybe getting to that place, as a not mentioned, where they don't need to be bailed out on a regular basis.

I thought that was really interesting. I mean, there are a few things that stuck out to me. One is just sort of this idea of examining banks is if the regular businesses is starting from the premise that, okay, this is a business, and we have all these successful businesses in the world that do not especially you know in Silicon Valley, that do not have particularly much credit financing, and yet they work, and so the question is like, starting from that standpoint, wire bank so much different, and how does that contribute to the risks? I also thought it was interesting her point that actually shadow banks are things that we call shadow banks, lenders that aren't necessarily part of the regulated bank system, in fact do hold more equity was very intriguing to me and to the idea that not only did they naturally hold more equity, but also presumably they wouldn't be as systemically important because of the lack of depositors. That's an interesting observation about how banks or financial institutions outside the regulated system work well.

I thought that was really interesting. I mean, there are a few things that stuck out to me. One is just sort of this idea of examining banks is if the regular businesses is starting from the premise that, okay, this is a business, and we have all these successful businesses in the world that do not especially you know in Silicon Valley, that do not have particularly much credit financing, and yet they work, and so the question is like, starting from that standpoint, wire bank so much different, and how does that contribute to the risks? I also thought it was interesting her point that actually shadow banks are things that we call shadow banks, lenders that aren't necessarily part of the regulated bank system, in fact do hold more equity was very intriguing to me and to the idea that not only did they naturally hold more equity, but also presumably they wouldn't be as systemically important because of the lack of depositors. That's an interesting observation about how banks or financial institutions outside the regulated system work well.

And they seem to be doing reasonably well right now.

And they seem to be doing reasonably well right now.

Right.

Right.

I haven't looked at like a publicly traded BDC share price lately, so you know, don't at me if this is completely untrue. But we talk about the golden age of private credit all the time and how quickly that industry is expanding, and in many ways they're doing the same thing that banks are, just without I guess the regulatory requirements attached to that, but also the funding benefits.

I haven't looked at like a publicly traded BDC share price lately, so you know, don't at me if this is completely untrue. But we talk about the golden age of private credit all the time and how quickly that industry is expanding, and in many ways they're doing the same thing that banks are, just without I guess the regulatory requirements attached to that, but also the funding benefits.

This idea of the obsession with return on equity, it almost sounds like, you know, a conspiracy between bank executives and the shareholders, right, which is obviously the shareholders don't want to get diluted by having more equity, and the executives want their salary to be tied to how much can they how much profits can they make on the equity, et cetera, but not necessarily being in the best interests of society and.

This idea of the obsession with return on equity, it almost sounds like, you know, a conspiracy between bank executives and the shareholders, right, which is obviously the shareholders don't want to get diluted by having more equity, and the executives want their salary to be tied to how much can they how much profits can they make on the equity, et cetera, but not necessarily being in the best interests of society and.

Techpositors who just want their money back.

Techpositors who just want their money back.

Yeah, exactly, Now, a lot of interesting ideas there. I'm glad we had her on.

Yeah, exactly, Now, a lot of interesting ideas there. I'm glad we had her on.

All right, shall we leave it there?

All right, shall we leave it there?

Let's leave it there.

Let's leave it there.