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Explore audio highlights, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.

READER COMMENTS

Floccina
Nov 26 2018 at 9:44am

Great discussion lead to many questions. My top 2:

1:

There is a question I never see discussed in regard to financial system. That is are people excessive risk avoiders and so our system that subsidizes risk helps long term growth? The developed countries are very rich, could it be partly due to the fact that because humans are risk avoiders that we are better off with this system that hides the risks and over compensates and insulates people who take big risks with our money?

2:

I think what we need is a financial system with feed back such that the failure of a few big financial institutions strengthens all the others and incentivizes the remaining finical institutions to make up for the decline in money supply.

The only person that I have seen propose such a systemic change that might result in such a system is George Selgin. He would have Government provide base money and let the banks create cash (bearer bonds), remediable not in gold but in the Government money.  If his system did not work the Government could always print more base money.

Seems to me more economists should working toward the goal designing a system robust to the failure of big banks.

Antonio de Sousa
Nov 26 2018 at 2:11pm

A bit disorienting, there was a lot of pot shots taken at many targets.  Seemed like if there is some sort of of list of left leaning annoyances then they had a sound bite on this episode.

As a classically trained economics student from the early 90’s the only class I took on banking was a corporate finance course in the school of business administration. I don’t recollect any economics courses on banking and finance. At the same time, as a someone in my early 20s I had very little experience on how important finance would become in my life (as just an average Joe).

The crisis of 2008 did perk my interest because I kept hearing people make statements like people should go to jail, the government should nationalize banking, it was the americans that caused the financial crisis. Just a background, I’m a dual Portugal and Canada citizen. From the portuguese media the fault lay totally with the USA and Europe as a bastion of socialist virtue was the victim, although the portuguese banking system was a total fraud by any measure. From Canada there was the sanctimonious policy suggestion for the USA of setting up a oligopoly of 6  – 8 “charted” banks.

In any case, the economy is too complex to even partially grasp it, and because of that everyone including ourselves are just winging it and trying to get by. I don’t think there is any concerted malevolence, only distributed ignorance, fog of war stuff.  The only thing I recommend is that we start from the assumption that we have to protect the “little guy” like my parents who can’t tell a bond from share, but need the savings they have accumulated from a lifetime of hard work to be safe and available. This should be the concern of banking policy, the other stuff like funding infrastructure and the next mega corps should come a far second.

 

 

 

Don Crawford
Dec 8 2018 at 11:07am

Interestingly, it is the desire to protect the retail customer from risk that caused FDR and friends to put in place the FDIC.  Depositors insurance means the customer is protected, but it also means the customer is effectively told that the amount of risk being taken by the bank is “none of your business.”  I believe that if we did not have FDIC customers would need to know the amount of risk being taken by the bank.  In order to attract customers banks would have to make transparent the amount of risk they are undertaking.  With a transparent metric customers could choose a bank based on how much risk they would like to undergo.  Then banks would have to de-leverage until the risk was low enough to attract the average risk-averse customer.  That is the market solution to this issue.  Very fundamental and simple.

Ultimately the argument that we need to protect depositors because they cannot assess riskiness is the same argument that is used to keep customers out of education and medicine.  The basic argument that these fields are too complex for customers to make wise decisions on their own is untrue.  The construction of smart phones, or cars or many commonly purchased items is well beyond the ability of customers to understand.  We customers can still make informed choices about which of the available options is best.  The market will continue to incentivize businesses to make better options available and to explain to us, in terms we can understand, why it is better.  As an educator, I know this would be possible (for businesses to continue to innovate and sell customers on these improvements) in education if a free market was allowed to exist in schooling.  I believe it would be true in medicine and I’m willing to bet it would be true in banking.

Peter
Nov 26 2018 at 2:38pm

Economists generally sell the story that they can control and fine-tune the macroeconomy.

Economists need this story to justify their salaries at places like the Federal Reserve and to even justify the existence of the Federal Reserve.

That’s a big reason economists don’t criticize the system, too big to fail, and Ben Bernanke. And instead they generally hold up these crisis era leaders as heroes.

Another reason investors hold Bernanke, Geitner, and Paulson in high regard is they avoided a worst case scenario during the crisis. Warren Buffett/Berkshire Hathaway was buying newly issued preferred stock during the panic from companies like Goldman Sachs, GE, and later Bank of America.

Andy Kneeter
Nov 26 2018 at 3:11pm

The Anat Admati podcast was excellent. I’d take her analysis even further in the following manner.

Modern banking is a fractional reserve system. This  is inherently fragile, because there are simultaneous dual liabilities on a single asset (deposits are the asset, the obligations to fulfill contractual lending commitments to borrowers  & demand withdrawal commitments to depositors are the dual liabilities).

You can have either of these liabilities at a time, not both.

Fractional reserve banking, while much more fragile than 100% reserve banking, would be legally acceptable, if contracts are clear (specifying either depositors aren’t entitled to withdraw their funds in shaky economic conditions or borrowers may have to repay their loans at an unspecified time).

This inherent fragility of the fractional reserve banking system, combined with perverse incentives (i.e. – “too big to fail” bailouts), creates the conditions of repeated boom/bust economic cycles.

Supported by clear & accurate contracts between all parties, 100% reserve banking would naturally evolve (where demand deposits aren’t lent out & funds for lending are delineated from deposits.). Fee pricing for these services would evolve naturally in free markets.

For further reading on this, I’d recommend Murray Rothbard’s masterpiece “What Has Government Done to Our Money?” (available as a free PDF download or audiobook on YouTube).

Jeremy
Nov 26 2018 at 7:53pm

Thank you for another interesting podcast. 

There is little discussion of the deep failures of the government and regulators. The inability of regulators to take action when conservatively managed banks complained about losing mortgage business to aggressive firms going down in credit. The failure of TARP to stabilize the system. The Fed holding rates too low for too long following the dot.com crash. The political pressure on Fannie and Freddie to push more low credit loans (basically subprime) to specific communities where voters will (hopefully) return the favor in the next election. The moral hazard from decades of financial bailouts (by government)..

On the difference between the dot.com and the 2008 crash, there needs to be a discussion on the microeconomic incentives – individuals who had watched their 401k savings plummet following the the dot.com crash who panicked and put remaining retirement money in what was sold as a traditionally a safe investment (by friends/family/business/ AND government) – homes / real estate. 

You really shouldn’t attack the single bank which was one of the few who successfully navigated the crisis (and saved pick-a-pay mortgage Wachovia who was going to be purchased by Citibank with your assistance) without tons of taxpayer money. If you don’t agree, try listening to the FCIC’s questions to Wells Fargo’s head of the mortgages. 

If you want to improve banking, let them fail and deregulate the industry. Dodd frank just killed the newcomers and competition – cementing the current players for a long time. 

As far as I’m concerned, the best Econtalk on the financial crisis is Charles Calomiris from 2009. 

Malcolm C. Harris, Sr.
Dec 3 2018 at 2:37pm

Jeremy,

 

You have a better list and Professor Amanti.  I agree Calomiris is spot on.  The economics profession has ignore the wisdom of its financial institution scholars like George Bentson, Ed Kane, Calomiris, and Mark Flannery.

Sir. John R. Hicks taught us we can not understand monetary economics unless we know the institutional context of the time we are studying.

Malcolm C. Harris, Sr.
Dec 4 2018 at 8:27pm

I left out George Kaufman.  My apologies, George.

msouth
Nov 27 2018 at 4:43am

The discussion of many of the forces involved in the crash was fascinating.

But more fascinating was at the end, where this boondoggle that has the government so deeply and inextricably entwined with the most fundamental pieces (free insurance for demand deposits!) was described as a “market failure”.

Even with the depth and seriousness of the guest’s realization that things were very different than they expected and that there is very deep rot, they still end up at the conclusion that what we need is more/different intervention–“my regulatory scheme would fix it”.

All that criticism of economists’ fear of stepping out of line (by which I mean “failure to challenge the orthodox view that things are fine and just need small tweaks”) rang hollow to me at the end when we got to prescriptions.  The guest has correctly come to the realization that mainstream economists are afraid to challenge the idea that the “big shots” saved us from the crisis when we should be recognizing that they caused or enabled it and have still not taken responsibility for it.  It’s a big step to realize that, and you risk becoming a marginalized outsider if you take that step publicly.  But it was amazing to me that, after all of that casting-of-scales-from-eyes, the guest seems to have the same visceral fear of taking the next logical step and becoming the ultimate marginalized outsider, by which I mean a misesian.  (Which is so marginalized that spell check doesn’t even recognize the word 😀 ).

Cognitive dissonance dies hard.

I wonder if it would help to call out phrases like “safety net” as straight propaganda.  “Of course we need a safety net“.  It sounds so unarguable.  Who would be so irresponsible as to suggest that we work without a safety net?  But this is exactly how Wells Fargo is able to “self-fund with deposits”.  The so-called safety net is the problem.  There’s no reason that a private entity or entities could not come up with some kind of insurance system that figures out the price of guaranteeing $250,000 worth of each person’s deposits.  And the bank should have to find such a service and pay for it if they want it.

There are financially solvent private insurance companies, and there’s no reason that the market could not provide this, as long as it doesn’t have to compete with the government providing it for free.

How can you criticize the whole idea of “gambling with other people’s money” and then support the primary enabler of that as a “safety net”?

Yes, people want a guarantee of some sort.  But giving people something they want without making them account for–and pay–its actual cost is a recipe for many, many, future “market” failures.

 

Kevin Ryan
Nov 27 2018 at 7:53am

I agree with most/nearly all of your points.  However this is an area where real solutions are very hard to find, and I would caution against believing that private sector insurance can provide an answer.

Even if free government insurance could be removed as a competitor, insurance companies are not better placed than banks to withstand the risks that materialise in an economic downturn.  Their diversification qualities only really apply to operational types of risks which, to date, have tended to be associated with idiosyncratic problems at individual banks.

There have been previous attempts to get insurance to reduce the risks in the banking systems.  If my memory is correct there were a number of insurance companies, including AIG, offering guarantees on financial contracts ahead of the financial crash.  Although these were designated as AAA, they were not able to pay up in any normal way when all the long positions they were insuring lost value at the same time.

This reflects one of the potential illusions in Finance – thinking you have eliminated risk, only to find that you have changed its nature and/or possibly made it both more obscure and complex by involving additional parties.

Mutual guarantees involving the entire financial sector have some attraction as reducing the risk of failure of any one bank.  But this is surely a black swan on steroids

Alan Goldhammer
Nov 27 2018 at 10:39am

Kevin Ryan writes, “If my memory is correct there were a number of insurance companies, including AIG, offering guarantees on financial contracts ahead of the financial crash.

They and others were writing credit default swaps on securities they had no understanding of and that were loaded down with junk.

msouth
Nov 27 2018 at 6:40pm

There have been previous attempts to get insurance to reduce the risks in the banking systems.  If my memory is correct there were a number of insurance companies, including AIG, offering guarantees on financial contracts ahead of the financial crash.

The problem I have with this line of thought is that the presence of FDIC–a guaranteed bailout with other people’s money!–means that we have an 85 year long innovation vacuum.  Novel financial instruments and arrangements are created all the time, but (essentially) no one spends time thinking about a problem that there is no profit in solving.

In another comment you agree with the guest that “significantly higher regulatory capital ratios are the only practical measure that could be taken given the inherent fragilities of banks and the realities of Too Big To Fail”.  I’m guessing that a lot of people who realistically observe the system think the same thing.  But an insurance company would have skin in the game, and people would start putting human thought and energy into figuring out what “significantly higher” actually means, and, yes, some of those schemes would fail, and we would learn from that, and 85 years later we would have, potentially, hundreds of millions of man-hours’ worth of thought put into this.  We have lost that innovation irretrievably.  The minds that would have been engaged on this worked on other things.

Lack of diversity in an ecosystem leads to wipeout events when an entity gets introduced that can successfully attack everything because everything has the same weakness.  FDIC’s stamp is on, I guess, literally every single retail bank in the US?  This is an unnaturally imposed condition, and decidedly non-market.  There should be competing schemes that people and institutions choose between, but we don’t have that because we have implemented a monoscheme by force.

When we do allow an actual search for market solutions to these problems–meaning, allow banks to fail if they are not responsible with the money they have custody of, allow insuring entities to fail if they are not properly auditing the banks they insure, etc.–and then we still fail to get it figured out, maybe at that point we can start talking about whether it’s a “market failure”.

From my point of view, calling these things market failure is like chaining people up and complaining about their lack of agility, and we’ve grown so accustomed to the chains that we don’t even see them.  (See also: centrally planned interest rates.)

msouth
Nov 27 2018 at 6:43pm

(Sorry, that first paragraph was supposed to be a block quote, but I think it got absorbed because it was already blue?  I trusted the system and it failed me!  That’s so contextually meta 😀 )

[Note to msouth: I fixed the blockquote for you internally; but I love your meta-observation. We apologize for the quirky inconveniences. We’re doing our best to work on it, but it’s a gradual process. Problems can always be emailed to us at webmaster@econlib.org. –Econlib Ed.]

Kevin Ryan
Nov 28 2018 at 1:08pm

Hi

Again I agree with most of what you say.  Although I share the scepticism of my one time boss, Adair Turner, about the value of financial innovation.

It is certainly stimulating to think about how the banking system would have developed in the absence of a TBTF philosophy;  and/or what a non-TBTF world might now look like;  and/or how we might get to such a place.

But I think that the main issue on which we differ is on the ability of insurance companies to play a big role in developing an alternative market/form of support for banks.

To me, insurance companies – and this is a generic rather than US-specific description – are just other financial sector organisations with a package of activities, some of which are similar to those of other players such as banks, and some of which are different.

They are run by people who are similar to those who run banks;  and run in similar ways.  (This is my prejudice – I may be wrong).  And insurance companies already have many activities which result in their being exposed to banks – on and off-balance sheet, and including investments in their equity and a myriad of debt/equity hybrids.  So skin in the game as regards the risk of banks is not something that would be new to them.

Don Crawford
Dec 8 2018 at 11:15am

I agree that the root of the problem is the notion of government sponsored deposit insurance.  I didn’t think of private deposit insurance as an option.  Interestingly, when things do private, immediately there are new incentives.  The private deposit insurance providers would require the bank to pay premiums based on the riskiness of their portfolio.  So less risk would reduce the premiums.  I also think that the market could provide a metric of riskiness that consumers could understand so they would only choose banks that were strong and not overextended.

Deposit insurance essentially says to the consumer that the amount of risk undertaken by the bank is “none of your concern” when that is exactly whose concern it should be.

Alan Goldhammer
Nov 27 2018 at 10:37am

Banks are forever living in a Minsky Moment and it’s almost like Groundhog Day when crises reappear.  I share Professor Admati’s concern about the solvency of the commercial banking system as bank balance sheets and regulatory filings are always opaque and bank examiners don’t do a good enough job.  We will never have the necessary regulations barring an Elizabeth Warren presidency (something that sends shivers down this Democrat’s body) or another major meltdown.  Dodd/Frank will continue to be watered down.

Regarding the comments about Wells Fargo posted above, yes Wells was solvent and in good position following the 2008 crises.  Their problem was one of corporate governance that either sanctioned or winked at a lot of bad practices.

Kevin Ryan
Nov 27 2018 at 12:52pm

Very good podcast.

I very largely agree with Anat’s analysis and also that significantly higher regulatory capital ratios are the only practical measure that could be taken given the inherent fragilities of banks and the realities of Too Big To Fail – but I am even more sceptical that there is any chance of this happening, even after the NEXT crisis.

Regulators have two roles – PREVENTING crises and limiting their impact.  The former is what they spend most of their on, but is less sexy than the latter and requires long battles against the banking industry and the politicians they are able to influence.  As Anat suggests, it is in this work that they need to show Courage.  It does not really require much Courage to use other peoples’ money to bail out banks when a large majority is urging you to do so.  If anything, in these circumstances, it would require Courage NOT to act.

But I would not put this down solely to banks funding politicians.  For one thing, being soft on banks is not solely a US phenomenon. Floccina has pointed out (above) the possibility that even imprudent banks might actually be wealth generators for society;  politicians, with their short term horizons, are much more interested in keeping banks lending to their electorates than more esoteric long term worries about banks’ soundness;  and they are easy pickings for the arguments of banks’ extensive lobbyists that tougher restrictions will lead to a credit crunch.  And it is the politicians that appoint the senior regulators!

In truth the banks’ arguments about the impact of tighter restrictions are not entirely without merit.  The big increases in leverage over earlier years have already taken place, and we do not know what would happen if there was an attempt to reverse this now.  The toothpaste is out of the tube.  By how much would lending be cut, and which lending?  What increase in capital would there be and who would subscribe to it?

It certainly doesn’t help that the regulatory capital system is so complicated.  But this is due to a combination of there being different types of risk in banks, the desire by banks (and sympathetic regulators) for choices to reward sophistication, and the imposition of additional measures in an attempt to address shortcomings in the standard measure.

As Anat’s October 2015 paper implies, it would be naive to think that sweeping this all away and leaving just a simple leverage ratio would be optimal.  Either you have to believe that all banks’ exposures are equal in risk – say risky real estate versus the nominal principal of an interest rate derivative, or the impact on some favoured exposure types is reduced by their exemption from the calculation or some form of offsetting.

In theory a new and improved single capital measure could be developed, aimed at public policy objectives that capital restrictions were seeking to achieve.  But as far as I am aware neither the regulators nor academia has developed/identified such a measure.  And even if it were identified it would undoubtedly encounter lobbying in policy development and shortcomings in implementation – which would likely frustrate its effectiveness in practice.  There would be resistance to any material increase in the requirements of any major bank.

Malcolm C. Harris, Sr.
Dec 3 2018 at 2:28pm

You, Professor Roberts, and Professor Admanti both allege that there were relatively little consequences of the Dot Com bubble’s bursting for the real economy.  This continues the myth that the the recession of 2001 was “mild.”  This myth was partly sold because the true damage was not fully measured until much later when the data was revised.   There is too much focus on GDP which is a lousy guide to business cycles and seldom depicts what is happening in a timely manner.  Moreover some 70% is imputed.

Employment dropped from its February 2001 peak until August 2003, almost two years after the recession was officially over.  Employment did not recover to the level at the peak until January 2005 almost four years later.  Employment as a percent of the adult population peaked in April 200, when the S&P500 peaked and a month after the NASDAQ peaked.  It has NEVER recovered to that level.  Where is the evidence that unemployed workers found new jobs?  I haven’t seen it.

Malcolm C. Harris, Sr.
Dec 3 2018 at 7:26pm

Deposit Insurance is inherently fraught with moral hazard as has been well known for a century or more.  FDR thought it a dumb idea as did Carter Glass, but, as Ron Chernow documented, they needed Steagall’s idea of national deposit insurance to  get something passed during the “100 days.”

A much lower deposit insurance level ($40.000?) and one deposits believed would stay at that cap would put more deposits at risk and cause at least some depositors to monitor.

This podcast keeps talking about “banks” indiscriminately. It is important to distinguish investment banks from commercial banks and from universal banks.

Large, geographically diversified universal banks are a better structural form than the fragmented system we have had through much of our history.  The crucial thing for a universal bank is for the adults on the commercial banking side to control the cowboys in investment banking.

Well managed large banks came out fine: JPMorganChase, Wells Fargo, and Toronto Dominion.  Bank America was doing the right things until Ben Bernanke forced Ken Lewis to buy Merrill Lynch. Later to let him twist in the wind.)  In what was truly an indictment of Glass Steagall’s separation of investment banking from commercial banking, all five major investment banks, none of which were regulated by the Fed’s, the Comptroller of the Currency, or the FDIC, are all either gone or now under bank prudential regulation.  (Lehman Brothers failed, Bear Sterns was rescued in a shotgun wedding by JPMorganChase, Merrill Lynch was absorbed by Bank of America, and the remaining two, Goldman Sachs and Morgan Stanley became bank holding companies.)  While Russ Roberts is surely right on in saying that converting from partnerships to publicly held corporations made them riskier, they also lacked the restraint of commercial bankers.

Stanford Weil, who lobbied the federal government to ex post facto legalize its violation of Glass Stegall and thus eliminate the legal separation of commercial banking and investment banking demonstrated he could not manage a universal bank without a Jamie Dimon.

Kevin Ryan
Dec 4 2018 at 12:22pm

Your view on the health of various banks is, probably, pretty widely shared.

The alternative one, which I think is what is put forward in this episode, is that all banks are unstable and that the main factor that allowed the ‘good’ ones to ‘come out fine’ was the action taken by the authorities to support the system as a whole and some individual firms directly.

One of the most obvious aspects of this is the extent of the untainted banks’ exposures to the weak ones.  These had been very large before the crisis and it was their understandable efforts to reduce them from the start of the crisis that then became a big factor in its escalation.

In theory, it is banks that should have both the skills and the motivation to monitor the condition of other banks;  but the crisis gave us little reason for optimism that they can do so.  Maybe Chuck Prince revealed the reality of risk management in big banks.  (Also this should make us sceptical that a low limit on deposit insurance is going to make any material difference to monitoring)

Finally I agree with you that diversification is going to reduce the risk of a bank, so geographically diversified universal banks have a clear advantage in that sense.  But, working the other way is that such complexity makes these banks even harder to manage;  and that because they tend to be bigger their failure would have more serious consequences.

Malcolm C. Harris, Sr.
Dec 4 2018 at 8:29pm

Banks do not have to be inherently unstable.

Canada, where banks face far greater systematic economic risks, has had no banking crises in a century and three quarters.  In the U.S. laws largely prevented geographical diversification.  These barriers to diversification have only been slowly eroded over the last three decades.

In the the Fall of 2007 I had the privilege of teaching Financial Institutions Management at Friends University for the first time ever.  Only a few hardy undergraduate students were willing to risk this new venture.  Each deeply analyzed a big bank and a little bank using the vast amount of publicly available information om them. building up a huge spreadsheet on each.  By semester’s end they were telling me which of the big banks were going under and which were going to prosper.  They were spot on.  This was five months before Bear Stearns and almost a year before Lehman.

Kevin Ryan
Dec 9 2018 at 5:54pm

Thanks for your response.  We can agree that some banks are riskier than others;  and also that diversification reduces that risk, albeit, in my view, this has its limits.

However it seems clear that we do not agree on the inherent riskiness of banks.  Here my view has similarities to that of Andy Kneeter in his comment of 26 November above.

I would say that the basic issue which leads to the instability of banks is the impact of cyclicality on their lending activity (and other credit products) – cyclicality in the economies and sectors they lend to, with the banks themselves contributing to and reinforcing the cycles.  As banks’ products are essentially commoditised there is a tendency to compete in the upturn by lowering credit standards and prices.  Once the cycle/sentiment turns many banks are trying to reduce exposure to riskier borrowers, thus reinforcing the downturn.

Does this mean that banks HAVE TO BE inherently unstable?  Well, there are simple (earlier) models of banking in which lending is done from the principals’ own resources, and deposits are taken on a safe custody basis.  If this were the case then it would indeed be hard to claim that such a banking system was unstable.  However this does not describe modern banks.  These have a number of features that contribute to their instability – in my view the following are the most relevant to the situation I describe.

Lending of owners’ money is supplemented by lending of deposits and other borrowed funds.  As is well known leverage increased sharply from earlier historic norms and it did not appear that major banks had well-developed internal policies on how much leverage was acceptable, with more obvious focus on arguing that regulators’ standards were too tight and needed to be loosened.

Because most lending has a longer term than the deposits and other borrowed money that funds it, banks assume a major structural funding vulnerability.  Funding must be rolled over or replaced by others, so it is essential that confidence be maintained.

Banks are closely inter-related with each other and so each bank is vulnerable to others encountering difficulties, especially in a downturn;  they have direct exposures;  they often rely on other banks to take on their lending/lending promised when they want to reduce their exposure;  the failure/loss of confidence in one bank leads to the loss of confidence in many others.

Related to the previous point, the source of repayment for a significant amount of lending and other exposures of banks is expected refinancing by other banks rather than free cash flow generated by the borrower etc over the lending period.  Banks have tended to have a lot of faith in short maturities and collateral as risk mitigants – which are unstable elements in a downturn.

Many markets attract in new lenders in an upturn who have a tendency to try to get out quickly in the downturn.  While understandable from their own perspective, a result is that the systemic banks need to take on some of these exposures when they would rather be reducing exposure to a sector.

Jonathon Bart
Dec 12 2018 at 3:23pm

Because most lending has a longer term than the deposits and other borrowed money that funds it, banks assume a major structural funding vulnerability. Funding must be rolled over or replaced by others, so it is essential that confidence be maintained.

I would say this is the fundamental issue with Banks in general: maturity transformation. Depositors want their deposit any time, anywhere, with essentially zero risk. Borrowers want the longest time possible to repay their loan. Banks sit between the two, essentially trying to give both sides what they want by pricing that risk to their clients. This is why simple checking and savings accounts, where the depositor has immediate access, pays practically nothing, while term deposits pay closer to market rates. In the same vein, rates are higher on loans as term lengthens, all things being equal. The Bank in turn earns a higher spread as it takes more transformation risk.
It’s a simple fact that unless a bank’s cash to deposit ratio is 1, regardless of the quality of assets its holds, if all its depositors want their money today, it is doomed. It simply couldn’t sell enough assets to meet the depositors’ withdrawals. Therefore, despite the juicy spread that banks make by borrowing short and lending long, it’s still not enough for a bank to be viable.

What is required is the phenomenon that depositors don’t all want their money at the same time. When this holds, then a bank can borrow short, lend a fraction (let’s call it 90%) long, and then use equity and remaining deposit funding to purchase highly liquid securities / maintain excess reserves at the Fed. This cushions the volatility in deposits, and allows the illusion that everyone has access to their deposit, when in reality they do not.

It is the maintenance of this illusion that has proven challenging since banking first started. A bank could have an incredibly diversified deposit base: customers, sectors, geography; and yet it doesn’t mean anything without this illusion. FDIC insurance was passed, for one reason, to solidify this illusion. To move past FDIC insurance, the perception of what deposits are needs to change. They can no longer be risk-free custodians of cash, but a form of unsecured debt with a certain seniority on assets.

Malcolm C. Harris, Sr.
Dec 4 2018 at 9:01pm

It was fortuitous that Ben Bernanke, who did the seminal work demonstrating the role of financial crises in deepening the Great Depression, was at the monetary helm when the crisis struck.  Give credit where credit is due.

Professor Roberts, you are often sympathetic to the Austrian view of economics.  Ben Bernanke’s biggest sins was not ones of lax prudential regulation, but rather sins of an overexpansion of credit.

The Fed did not regulate Countrywide, Washington Mutual, Bear Stearns, Merrill Lynch, Morgan Stanley, or Goldman Sachs.  Nor did it regulate AIG.  It did regulate Bank of America and forced it into the disastrous rescue of Merrill Lynch.   It can be faulted for its regulation of CitiCorp, or at least Citi’s bank holding company. Perhaps most importantly, it had no authority over Fannie Mae and Freddie Mac, those two “paragons” of crony capitalism which required the biggest bailout of the crisis, $180 billion.  Curiously, the thousand plus pages of Dodd Frank make no mention of Fannie and Freddie.  If Dodd Frank was the bill to end all financial crises, you will agree The Great War was the war to end all wars.

Bernanke was not the guilty party for the failure of prudential regulation; his sins were macroeconomic.  Professor Bernanke first as a Governor and then as Chair presided over the monetary policy that fueled the housing bubble and the related pyramid of esoteric securities.  All three of the last recessions and their preceding booms were Austrian in nature.  That nature and the mechanisms involved were presciently laid out by Sir John R. Hicks in 1989, the year of his death.

Mohammad
Dec 5 2018 at 1:42pm

What I did not like about the guest’s viewpoints is her self righteousness: naming people in academia or Fed and claiming that they did this or say that not because they were wrong but since they had some interest in deceiving the public or a moral failure. This kills any sort of intellectual dialogue. Somebody else can accuse her that she just wants to take the more popular stance. How can such accusations be informative?

She is trying to make a case against all financial economists who do not share her views and claims to be among the very few who get it right now and want change. This is simply not true.

First many others in that literature have similar criticisms of high leverage in banking and moral hazard issues. It is easy to name papers and researchers. Just to give an example of her false representations she mentions that the Squam Lake report missed this point. One of the points made in that report (chapter 5) was exactly to increase bank capital to overcome the moral hazard issue.

Second. Those academics who have some different view (e.g. do not favor more equity financing, put more weight on Feds inability to respond) normally support their ideas by economic reasoning: models and empirical evidence. To argue that “their models are reverse engineered” is a cheap shot; in a way all models are reverse engineered. Worse than that is claiming that they have some sort of a moral failure. When criticizing an economic model or argument she should stick to the economic reasoning which is what’s expected from a financial economist and where she can have a positive contribution. Demonizing opponents on policy issues is politicians’ comparative advantage not hers.

Jonathon Bart
Dec 11 2018 at 4:21pm

As a liquidity risk professional who has worked at multiple systemically important financial institutions (SIFIs) starting in 2008, I find these Financial Crisis podcasts (the Calomiris episode remains one of my favorites) both interesting and frustrating.

What made the 2008 financial crisis so unique is that it was a failure of credit risk and liquidity risk, linked together by the fact that many of the firms utilized that very credit as collateral for liquidity. The five banks that resulted in bail-outs or failures that come to mind: Bear, Wachovia, Merrill, Ally Financial, and Lehman; most likely would have had the same outcome if it was strictly a solvency issue. It may have taken a bit more time until failure, as losses are realized over time, and their capital positions eroded. But in the end, they all made a ton of bad loans; sooner or later, it was going to hit their capital.

This was all compounded by the fact that while credit risk was an established risk function in banks, liquidity risk was not. Sure, all companies – finance or not – subconsciously manage their liquidity risk. They know they shouldn’t have all their debt mature in one day, month year, or years.  That deposits from wholesale counterparties – who mostly have full-time Treasury staffs plugged into Bloomberg – are much more responsive to news headlines and market turmoil than the average individual or small business.

The problem is that liquidity risk management wasn’t formalized, with the proper risk appetite setting, metrics, monitoring, and governance. No one on the Board told management what their risk appetite for the amount of funding maturing in a 1/7/30/90/360 day window was. As such, there was no limit that was tracked and, if exceeded, remediated. The discipline, from governance all the way to remediation, didn’t exist.

Which is the recipe for a huge problem. Some banks cranked up their production of shoddy loans, funded short-term and backed by the same shoddy collateral – whose maturity, collateral, and counterparty profile was not properly managed. Once the collateral quality was realized, everything collapsed much faster than it would have taken to see those firms bow out through insolvency.

The one benefit for the financial crisis was it forced both the industry and regulators to formalize the liquidity risk function (which is why I have a job!). In tandem they developed the lexicon, which allowed the regulators to build out the regulatory side, and the firms themselves to be introspective on where their liquidity risks are manifest. The end result is a two-prong approach. Regulators have established a set of minimum standard metrics: LCR, NSFR, etc. for all banks to adopt and adhere to, while requiring the largest banks to provide daily/monthly a entire liquidity dataset of their balance sheet at the transaction level (FRB 2052a). This is then buttressed by regulation (Reg YY) that forces banks to build governance, policies and procedures to actively identify, assess, document, and manage liquidity risk on and off balance sheet. It’s then at the behest of the firm to prove to the regulator that what they have established is up to the challenge.

The net result is that while capital ratios may be lower than some like – including the guest – banks are holding orders of magnitude more liquidity then they ever have. JP Morgan, in their 2017 Liquidity Coverage Ratio disclosure, disclosed holding half a trillion dollars in unencumbered central bank reserves or securities issued or guaranteed by the U.S. Treasury. Today, most (if not all) large public banks actively disclose liquidity risk items in their financial statements.

On the capital side, TLAC: total loss absorbing capacity, which is debt that can be converted to equity by the regulators during a solvency crisis; will soon be required to bolster capital positions. And the Fed is more actively limiting dividends of the largest banks whose capital plans do not meet its muster.

So I think unfortunately it took a massive-scale combined solvency-liquidity crisis in order to prompt the necessary regulatory and industry changes needed for a more safer-and-secure financial system. I say this because if it was only one firm that went bust in 2008, there may have still been enough inertia to continue doing how things were done. But instead, we have a newly established risk pillar that was sorely lacking. Unfortunately for shareholders, this new pillar is extremely expensive, which is driving a lot of calls for reducing the regulatory burden. My only hope is that these risk/expense trade-offs are given proper consideration, and not tilt too far in one direction.

Alan Brown
Dec 12 2018 at 12:37am

I don’t see any need for depositors insurance at all.  If a bank fails, let the shareholders lose their money and let all of the assets become owned by a new public corporation.  Give the shares to the former depositors in proportion to how much they ad on deposit.

They can sell if want or need to.  Or they can hold until the value of the loans recover.  And, yes, they might lose some money even if they wait.  Perhaps people will more attention to how careful a bank is at loaning its deposits.

But if I really wanted to make a safe bank, I would restrict its lending to just first mortgages, arrange for it to always be paid first and never lend more than 60% of the 7-year moving average of comparable properties.  This money will earn a low interest rate but it will be safe.

Make 20% down mandatory for these mortgages and get another mortgage for the amount over the conservative portion described above.  These could be repackaged into a single mortgage for simplicity with a blended rate.  The faster home values rise, the higher the rate would be.

I suspect a bank that just focuses on such mortgages and nothing else would be very safe indeed.  No FDIC or bailouts or short sales required.  And no bonuses paid to managers either.  Just loan out the deposits in a very predictable safe way.

Jonathon Bart
Dec 12 2018 at 2:51pm

I don’t see any need for depositors insurance at all.  If a bank fails, let the shareholders lose their money and let all of the assets become owned by a new public corporation.  Give the shares to the former depositors in proportion to how much they ad on deposit.

Banks fail for two reasons: they are either illiquid or insolvent. If the Bank is illiquid, then your plan would work because there is still value in the underlying assets. It’s just a matter of injecting liquidity into the Bank, whether that’s in the form of equity, market term funding, or even central bank term borrowing. In this case, the Bank is essentially pulling-ahead future earnings to meet its present liability obligations, and only works if the asset side of the equation is sound. If there is a deficient asset base (i.e. insolvency), then pulling ahead future earnings just kicks the can down the road.

If the Bank is insolvent, where losses on assets exceed equity, then your idea works so long as losses don’t wipe out non-deposit funding. In this case, creditors would essentially ‘bail-in’ the Bank, by converting their debt into new equity to recapitalize the bank. Interestingly enough, Canada just passed such a provision last Spring, which went into effect this September (see: Bank Act and the CDIC Act).

If losses exceed equity and debt funding, then there are only three options:

Raise new equity through private markets;
Raise equity by converting deposits into equity, or
Raise equity from taxpayers (bailout).

Because of FDIC insurance, we have basically replaced $250K of #2 into #3. Furthermore, typically #1 and #3 are done in tandem, where the government gives asset guarantees in partnership to induce private investors to re-capitalize the Bank.

But if I really wanted to make a safe bank, I would restrict its lending to just first mortgages, arrange for it to always be paid first and never lend more than 60% of the 7-year moving average of comparable properties.  This money will earn a low interest rate but it will be safe.

Make 20% down mandatory for these mortgages and get another mortgage for the amount over the conservative portion described above.  These could be repackaged into a single mortgage for simplicity with a blended rate.  The faster home values rise, the higher the rate would be.

I suspect a bank that just focuses on such mortgages and nothing else would be very safe indeed.  No FDIC or bailouts or short sales required.  And no bonuses paid to managers either.  Just loan out the deposits in a very predictable safe way.

I believe this was the concept of the Savings and Loan, which was common in the U.S. prior to their implosion in the 80s. I think the problem with the S&L at the time was that depositors wanted market interest, while they were originating fixed rate mortgages. When rates spiked, not only did liabilities became more expensive than assets, but the firms could not originate enough new assets to offset the negative spread in their portfolios.

A modern S&L could work if they did a better job managing their interest rate risk, both by managing a positive net interest income, as well as using hedges to mitigate changes in rates on that net interest income. It would be interesting to see if modern interest rate risk management techniques: hedging, modeling, and so forth; would make these types of financial firms more viable.

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DELVE DEEPER

This week's guest:

This week's focus:

Additional ideas and people mentioned in this podcast episode:

A few more readings and background resources:

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AUDIO HIGHLIGHTS
TimePodcast Episode Highlights
0:33

Intro. [Recording date: November 1, 2018.]

Russ Roberts: My guest is Anat Admati.... Our topic for today is the Financial Crisis of 2008. We're in the 10th anniversary of that. And, we're also going to get into, I hope, the role of the financial sector in general. And I hope also some corporate governance issues. I want to start with what you've learned personally from that crisis, if anything. Some people have said, 'There was nothing new there; I wasn't surprised; I didn't learn anything that I didn't already know.' That isn't true for me. I'll talk in a minute about what I've learned. But I'm curious what you, who, you are in Finance--so, what did that experience either get you to reconsider or get you to learn about that you didn't know about before?

Anat Admati: Oh--it changed my life. I mean, it taught me so much. I can no longer be what I was a decade ago. It had woke me--

Russ Roberts: What was that?

Anat Admati: Well, I mean, I basically realized I lived in a sheltered bubble that involved many, many false assumptions. I was working on the wrong set of problems, not on the problems that mattered. I was uninvolved in policy, and that changed. So, everything, from my teaching to my research to my activities professionally--everything has changed about my career trajectory. I'm still a professor at Stanford, but I talk to a different set of people; I think about a different set of problems--you know, related, as an economist, but now I'm much out of my silo.

Russ Roberts: So, the bubble you mentioned: What was the nature of that and what had to be re-evaluated once you saw what had happened?

Anat Admati: Well, I mean, in one word, assumptions. Implicit assumptions. Things we take for granted. I just didn't know that so many of them are wrong. Assumptions about markets, assumptions about financial market and the financial sector. Assumptions about politics. Assumptions about people, and sort of almost the sociology, even ethics of people. All kinds of things like that.

Russ Roberts: So, give us some examples of what you believed beforehand that you no longer think are true.

Anat Admati: At research 10 years ago you'd find me--the topic I was interested in was already corporate governance. And there, the problem that economists and law-and-economics people obsess over is entirely the problem of the sort of manager/shareholder conflict, because clearly we believe the purpose of corporations is to, you know, in the Milton Friedman language, to make as much money as possible--you know, subject to the rules and ethics he adds. And in the way we teach corporate finance to basically maximize the stock price. And that's what I've been teaching in Corporate Finance class. And so the only issue is you have dispersed shareholders, especially in a public company: How do they monitor managers? Those kind of things. Activist shareholders. So, I wrote a paper with Paul Pfleiderer about large shareholder activism: we've written a couple of papers on that. The free rider problem of monitoring. Things of this sort. Voting--I had students working on corporate governance. And, I never also looked at financial institutions as corporations. It was very general. And I realized that when you say that the purpose of the corporations is to maximize stock price, or to make as much money as possible, or you frame that purpose, there are implicit assumptions there that are just false in reality. And certainly false in the reality of financial institutions. For example, implicit assumption there is that markets, free markets, are competitive, and especially that somehow the contracts and the rules of the game, the rules of society as embodied in the law, to use the language of Milton Friedman again, are there to ensure that other people impacted by corporations--for example, customers, employees, the public as a whole--are protected somehow. You know, that everybody can have a contract except for the shareholders and therefore the shareholders should be the focus of what corporations, who corporations strive to get. Whatever that actually means. And again, unpacking who the shareholder is, it's as if a shareholder is somebody who only owns that one share and cares about the wealth that they get from the ownership--meaning the stock price. So, all of that embodies a lot of assumptions. And, when I started looking at banking and emerged out of that deep dive into the banking sector and financial crisis and what happened there and the narratives around that, I realized that, especially in banking but also more broadly, there are assumptions around, for one thing because contracts are often imperfect and costly to enforce, and require, you know, they are complicated there are all kinds of clauses you can think about, you know, mentor arbitration or the way the legal process is costly or monitoring to sue or legal costs of the different sides. And, because the laws are themselves part of a political process in which corporations or certain people in the economy have a voice; and the voice even in a democracy does not necessarily bubble up the most efficient set of rules. And so, you can have a failure of the rules; and the failure could be a sort of feature, not a bug, of the way the rules are created and enforced. And so, you know, the financial crisis if you want to get into that really represents that kind of failure of markets, contracts, and rules. And that's not always a narrative you'd hear from the people who, you know, prefer other narratives. But that's where you can see what people will say and do in their own interests if they can get away with it.

8:10

Russ Roberts: Well, I think that's an interesting way to frame it. In many ways, I agree with everything you just said. I guess in other ways I'm not sure I agree. We'd have to--let's dig a little deeper. As I see the--I learned something similar. But I was different. I wasn't paying much attention to the financial sector. As a non-Finance economist, I always viewed Finance as 'something over there.' It was something--it was a specialized thing: it was a very specialized part of the economy. And I was very unaware of the way that the fingers of that industry reached into all kinds of places. And I also was unaware of what the failure of those firms would do to the economy as a whole. So, you know, I like to make the analogy with the Dot Com struggles at the turn of the century when a bunch of dot-com companies that had great hopes--those hopes weren't realized. Those companies went broke. The investors lost all their money, every penny. And it was unpleasant for a bunch of people who worked in those firms; but many of them, of course, were able to find work in other firms that didn't go broke. And, there was no macroeconomic consequence, at least, that was measurable or widely observable or obvious from that failure. When the financial sector had a meltdown, the whole economy seemed to collapse. People went crazy. People panicked about whether society could survive, even--that people might not be able to get their cash out of their ATM machines [Automatic Teller Machine]. And it provoked a set of responses that were wildly different from the dot-com struggles. So, what's the difference between the two? And one of the differences--well, go ahead. You go ahead.

Anat Admati: Well, yeah. We give that example also in the book that you interviewed me about 5 years ago. Exactly asking that question: Why was the financial crisis so harmful? And, in comparison to the dot-com collapse. Which, just to set it up more as a contrast, that dot-com collapse involved a lot more sort of paper losses, what you were just referring to--meaning collapse in the value of certain companies, indeed their demise in many cases. In the financial crisis that started with subprime defaults, the underlying losses were actually much smaller. And yet, the harm was so large. And what it is about, a lot of it, was about the nature of the system--indeed, the reach of the system and the fragility and opacity of this system: the way that it controls sort of important infrastructure, like the payment system related to whether your money is in the ATM. And the way it became so global and so connected and then so incredibly fragile. And that fragility creates all these contagion processes that did not exist in the dot-com, which was just a contained system where equity values dropped. Here you had equity values dropping in a very highly indebted chain of highly indebted companies, where their counterparties weren't quite sure how to analyze who is really sound or not. And that created many mechanisms that, in our book, we call them financial banking dominoes, to describe it.

Russ Roberts: And so we agree on that. And we certainly agree that--I know we both agree because I've interviewed you twice and I've read your book, the role of leverage, of borrowed money, as opposed to equity. And just to review for listeners: In equity, you own stock. A stock can go up really, really high, and it can go to zero. With debt, you get a fixed return; but presumably the odds of going to zero are very small. You get your money as long as the firm doesn't go bankrupt. So, the idea, at least on paper, is that debt is a little bit safer and you give up the upside to have the lower risk of the downside. And yet, all these firms, and all these investors, and all these players in this game--it lent enormous sums of money, taking enormous risks of a possible downside, knowing that the firms they were investing in through their lending had almost no skin in the game. Almost no money of their own. Very little equity. Which normally would mean that you'd be very nervous about giving up the upside and accepting a lower return for a smaller risk of the downside; in fact, the downside was quite likely in those cases, with such small amounts of skin in the game, small amounts of own money. And, when I look at that fragility that you are talking about, I notice that Wall Street went, in a very short period of time in a partnership system where people spent their own money to a world where they spent other people's money. And, of course, that's always fun. It's more fun to spend other people's money. But the question is: How do you get those other people to invest in you? And I think that's the question.

Anat Admati: Okay. So, let me explain. First of all, think of just basic banking. And that's really where you get from banking and then from investment banking to kind of universal banks with everything in them, the kind of big banks that we have. But even when you talk about the basic bank, which gets its funding from depositors, of--first and foremost, depositors are very special kinds of lenders. They don't even think of themselves as lenders. They may give--I mean, and not only that--it gets, in the bankers' mind, especially now with deposit insurance, you know, you can get--and I like to use that quote to kind of explain to people how ridiculous it can get--the CEO [Chief Executive Officer] of Wells Fargo Bank, ex-CEO at the time a couple of years ago, John Stumpf, he said this in 2013, so shortly after our book came out, he said the following to a reporter: 'We, in Wells Fargo Bank,' he said, 'We have a lot of retail deposits.' He called it even 'self-funding by deposits.' That's my money, by the way--

Russ Roberts: Yours and mine--

Anat Admati: 'And therefore,' he said--now listen carefully. 'And therefore we don't have a lot of debt.' That's what he said. Now, you know, when I present now, I sort of put a big 'Huhhh?' on it. Like, 'What did you just say? You mean, you forgot you owe me the money?' I expect--we expect this money to be in the ATM, right? We trust that. But he forgot he owes it. Because it seems to him, it feels to him, like play money. It feels to him like--and the reason is that we feel safe because of deposit insurance. We do not monitor him. We do not breathe down his neck.

Russ Roberts: Correct.

Anat Admati: And we are the nicest creditors in the whole economy. Even though--and we don't have any collateral. We don't have any safety there. We just have the safety of the FDIC [Federal Deposit Insurance Corporation]. Now, as a result of that, what happens is, in banking, banks can be--especially today with safety nets in place--they are forever, you know, heavily indebted--although we can go back to history when they weren't, before safety net, as indebted. But, critically, normal borrowers in the economy, especially normal other corporations but even the kind of borrowers to which the banks themselves lend, if they become heavily indebted, they feel it. You were just saying: The interest you invest in loans, you basically start having your lenders be concerned with what you are doing with your money, with whether you can pay or not. They are going to choke you. So that companies that are very heavily indebted end up seeking bankruptcy protection or defaulting. Now, here's what's special about banks. Banks can stay insolvent for a very long time. Because nobody really calls them on it--

Russ Roberts: Nobody knows--

Anat Admati: nobody [fault]? So this hidden insolvency, to my mind right now, I have every reason to believe that many banks are either insolvent or very close to insolvency. And nobody really knows it. And then when we panic--when we think something's wrong--then we see who is swimming naked in the language of Warren Buffett, you know, when the tide goes down. So, in other words, we live in this make believe where, you know, they might even flaunt all kinds of capital ratios and regulatory ratios and or, you know, some kind of accounting number, to me. But what I see, I see the symptom of heavy indebted and distressed: there's no companies as indebted as banks. I mean, they have single-digit equity in a good day, relative to total assets. And a lot of balance sheet exposures that would not allow companies to actually survive in markets anywhere but banking. But, there are coddled, and they don't live in actually markets; which is how you can hear these ridiculous, entitled things that they say. And then, the somehow acceptance that that's okay for a company to live like that, just because it can.

18:32

Russ Roberts: So, the insolvency--just to clarify this--it very well may be the case that there are not enough assets--

Anat Admati: yep--

Russ Roberts: available for the bank to pay off everybody's creditors. But because we are not all asking for it at once--

Anat Admati: exactly--

Russ Roberts: or even close--you know, I go in and make my $150 or $200 [?]--

Anat Admati: Yep. We have excess deposits. Notice, by the way, that they can take the excess deposit, because they always have them, because we always leave extra money in the bank, and use assets that they buy with them as collateral to get the next person to lend to them. And so you have, then, on top of the deposits, a whole, huge, you know, high rise into the stratosphere of debt funding where everybody feels safe. And that's how you get to borrow as much as banks--you get people to lend to you and you get to live on almost no equity. And when you make money, when you have profits take the money out without any creditor screaming.

19:34

Russ Roberts: So, one way to look at that claim you've made--which I agree with--is you are saying that, just because everything looks okay, means actually it's not; there's no reason to think that it's okay. In, fact, because of the incentives in place, it's probably not okay. Which means that some bump in the road, in the case of the housing crisis it was the drop, unexpected drop in housing prices that forced the water to go down and people could fine out who was swimming naked. But that's coming potentially in some other market. So, you are worried.

Anat Admati: Yep. Yeah. I mean, right now you can read--I mean, I was just looking at that story and saving some of the graphs. So, now there we are talking about leveraged loans. I mean, if you go and look now, they are saying that there's huge--you know, there's a lot of what's called yield chase, you know, in the days of zero interest rates people want to take risk. And so there is a build-up of all kinds of risk. I mean, you know, I'm worried about cyber-security risk, but there are other risks that come and especially we're back to the days of what's called leveraged loans. Meaning, you make a loan to somebody who is heavily indebted themselves. Just like subprime homeowners were. In other words, a big risk of default. And these are very opaque loans. They are not like--you know, they overtook what's called Junk Bonds, actual bonds in markets that are rated and all that. They are called leveraged loans, and then they securitize them, very similar to the way they handled subprime lending. So, now we have a huge increase in that to the levels that are beginning to worry all the regulators. So, if you read now, everybody is saying, 'Oh, this is where the risk is going to come from. I was just looking at a Bloomberg story, literally before we talked, which says--the title is "As Fed to Oaktree Fret Risks, Leveraged Loans Hit New Milestone." This is just a story from October 18th, and it has various graphs, and it quotes somebody at the end, Michele at JP Morgan Chase Asset Management saying, 'There is potentially overextension of cheap borrowing. That's always what seems to get the system in trouble.' A year ago, just on a normal day where we are looking at mid-term election or whatever else and not paying attention, and here is the risk building up. Same as it was, you know, 2006 was a wonderful year. And I often go through what the regulators were looking at and what the regulators were missing. And all the measures that they were using that proved completely useless and how all of a sudden, you know, panic hits; and if you listen to Ben Bernanke, they pulled out all the stops, so if you read Adam Tooze now, spectacular things were done to save the system.

Russ Roberts: Well, I find those--to be honest, I find those very depressing and a little bit offensive. Because, what they did was they enshrined the rules of the game that were in place to help make money for those folks, instead of questioning them, instead of forcing a reassessment of what they're role was and the problem being there in the first place. And so, I feel like, my profession--I was going to say 'our' profession; I don't know if we consider ourselves in the same profession--but my profession of economists, not just finance--

Anat Admati: Yep, economists--

Russ Roberts: have done a great disservice to the country in saluting Bernanke and others--Geithner, Paulson--for saving the country, when in fact the mistakes that had been made along the way helped create the problem. And then, to think, congratulate the people who started the fire for putting it out seems like a bad thing to do.

Anat Admati: Exactly. And so, when Bernanke wrote his book, you know, when I only knew the title of the book before it came out, you know, The Courage to Act, you know, this self-congratulations; and then when you hear the narratives now--'they brought back the team: Geithner and Paulson.' And they were the heroes for the banker; but they are starting the story from when the implosion happened, and that's when they were heroes; and if you hear about the heroism, I mean it was really unbelievable what they did to help, not just U.S. institutions but the entire--because there is, currency and there was so much exposure to dollar debt in Europe and other--there was a select set of institutions, and it was selected even politically--to whom the spigots were opened, and the Fed, beyond the government bailout themselves, TARP [Troubled Asset Relief Program], etc., the Fed was just, you know, throwing trillions of, you know, they call liquidity, to prop up a system that they've allowed to become as fragile as it was. And then, so I wrote an op/ed at the time called "Where Is the Courage?" and it was really about the courage they didn't have before the crisis; and since the crisis to really question, as you said, whether this system is okay, and what can be done. They will have the story, 'Yeah, yeah, yeah--we didn't have enough equity and we figured that out and now we have more.' But, I mean, the 'more' is like the smallest tweaks--it means nothing. The 'more' is like in Martin Wolf's world, tripling zero. Which is still zero. In other words, you go from nothing to a little bit more than nothing, and you call it 50% increase or triple or something like that when you started with--you know, I don't want to get technical into these details but I can speak to them. You started from just an unfathomable set of standards and when you now tell me that it's stronger, which is just--is not asking the question, 'Is it the system we want? Is it as strong as it can be? Is it the right system? Does it continue to have the same ills that it had before?'

25:52

Russ Roberts: So, let's back up a little bit and let's talk about a couple of the things that I think are at the heart of the problem, which you may or may not agree with--but, you may. So, I want to hear your take on it. So, the FDIC [Federal Deposit Insurance Corporation], the insurance of deposits, of course means that, as you pointed out: I, as the depositor, person putting money into the bank, I don't want to have to worry about whether the bank is going to take too much risk with my money. And that worry gets transferred onto the Federal government, which gets usually implemented via various regulations restricting how risky banks can be. For the investment banks, there is no explicit FDIC, but there is an implicit bailout promise of, 'If things get really crazy, of course we are not going to let you lose all your money as lenders, because that will have too many ripple effects.' That, of course, encourages banks to be very leveraged, to have very little skin in the game; as you point out, to have, say 1% in equity and 99% borrowed. And then, so, of course, then they say things like, 'Yeah, so the assets'--

Anat Admati: Stuff happens--

Russ Roberts: 'assets have to be safe.' That's the whole Basel set of regulations--

Anat Admati: Yep. Risk points--

Russ Roberts: about how much Triple A, and weights, and how much of each kind you can have. And that whole hierarchy of, that infrastructure of supervision, monitoring, regulation, and implicit promise seems to me to be an utter failure. There's no reason to think that that's a good system. And I would just add: That has nothing--to me-to do with markets. It's not a market system. You have profits to be made and losses to be put on other people. That's just like the opposite of markets. And that's a destructive, inequitable, despicable, wasteful system. And that's what we keep perpetuating.

Anat Admati: Yes. That's right. So, Martin Hellwig and I, who wrote a number of pieces on this, recently thought to write yet again to explain, the following paper--it's called "Bank Leverage, Welfare, and Regulation." And it basically says that the inefficiency of banking is fundamental to banking, and it really has to do with--you know, they always say banking has always been fragile. To which, basically we are saying banking has never been efficient. At the start, when banks were partnerships--and you mentioned partnerships--and people who wanted to have that kind of liquidity thing--like, they wanted to put deposits in the bank--you know, really demanded that the bank had 50% equity and that the owners of the banks were personally liable. It's as if Jaime Dimon had his assets on it, would insure his deposits with his own apartment in New York or whatever. And then--but of course, then, the banks had to be very small. And, you know, they couldn't provide as much funding for the state and for everybody else. And so, but they the last to become even limited liability corporations, and they were even--they were double and triple unlimited liability in the United States even through the Great Depression until the FDIC was created. So, fundamentally what you need is somebody that--you know, the lender or the collective of lenders, or regulators--to ensure that the bank doesn't do what it has incentives to do: which is to endanger the deposits and everybody else and say, 'Oops, sorry,' and then there is a collateral harm. So, the problem really is that banking has never been effectively regulated, and markets are repeatedly failing, because it's hard for a depositor to really know what the bank is doing--you know, going to yet another depositor and sort of increasing the risk of default. And so, you know, we kind of delegated that to the regulators: it's just the minor problem that they keep failing and keep maintaining a bad system. So, yes: I think that Basel--Basel, the way it was coming into the crisis was a spectacular failure. And I can just tell you how many things were wrong with it. And that what they called a 'major revision' was really just tightening a few screws. But it really didn't improve it that much. And it remains this game of, you know, of playing around with the risk weights and finding ways to increase, you know, to kind of game it; and this whole thing; and putting it off balance sheet; and what's called Regulatory Arbitrage--this cat-and-mouse game that continues to go. And that's because it's all so complicated and so unfocused on the right things. And it doesn't ask the big question, which is--there's no science behind it, for sure. I mean, the papers they wrote to justify it are just completely flawed. And we've been taking them on for literally a decade. But yet, you know, they just keep saying these things. They just keep doing these things. So, you know, you asked what I learned. I learned that there is so much of this wrong stuff of bad policy that can persist.

31:15

Russ Roberts: I want to go back to this issue of the role of economists and academic business professors in this kind of situation. And, I'm going to be a little bit cynical. You could debate whether it's legitimate or not, the cynicism. But, let me put it out here. It seems to me that everybody knows what you are talking about. I know what you are talking about. We're not alone. There's at least two of us. But I think there's a lot more than two of us that understand that there are many, many ways--I could say, 'Well, I'd like to have a system with no bailouts and no deposit insurance, and therefore let all the costs fall on the people who make bad decisions.' And that's a lovely thought. It's unlikely; but that's my--

Anat Admati: Right. Not credible--

Russ Roberts: It's not credible right now. We don't have a cultural reason to have--

Anat Admati: No, no; and I think it's not even good. I don't even--I'm not even against deposit insurance and stuff.

Russ Roberts: Okay. So, that's fine. But, we all understand that, given the current reality, where there is deposit insurance, and where there is an implicit promise of a bailout, even when we legislate against it by the way, we end up doing it anyway--

Anat Admati: Yeah--

Russ Roberts: So, we had FDICIA [Federal Deposit Insurance Corporation Improvement Act], which is a way of dealing with bankruptcies that was basically short-circuited, because--

Anat Admati: from corrective action--

Russ Roberts: Right. Because we can't just--it was too risky. So, that incentive is going to always be there when powerful people have a chance to be bailed out. They are going to get bailed out. So, it seems to me that those of us who understand those incentives should call out and say: 'Well, given this reality, the only way to deal with this is to have very low levels of leverage; very high levels of equity.' Which is what you've come out for.

Anat Admati: Yep.

Russ Roberts: Now, that, to me, you can debate--and I know you have--whether that's got a cost or not. I don't really care. The cost of it is small compared to the costs of the ongoing failures of the financial system that happen and then lead to cynicism on the part of the public--correctly so--about how the system is rigged against the little person in favor of the big person. So, why isn't it the case that your colleagues and my colleagues who know this and instead say, 'Ben Bernanke did a great job,' instead of saying 'This whole system is corrupt'? It's corrupt. It's not just like, 'I think we have a better policy.' No. It's corrupt. It allows a group of people--you can debate whether they should have gone to jail or not: I don't think there's that much criminal activity. But what they did was shameful. They took advantage of rules that they themselves had influenced tremendously. It's not just that they played by the rules of the game. They influenced the rules. They made enormous sums of money. And the people who lost money were left with enormous sums anyway. So, Jimmy Cayne, the CEO [Chief Executive Officer] of Bear Sterns--he lost a billion dollars. Which sounds horrible. But he was left with $500 million. So, it's not like he was a pauper after it was over. He was not a pauper. So, the downside for these folks is glorious wealth that is beyond human imagining, through most of history. And I don't understand--well, I do; there's theory--but I want to hear your reaction. It seems to me that our colleagues should be out there saying, 'There's only one way to fix this that's reasonable,' which is higher requirements of equity and lower allowed leverage. And get away from all this sophistication which is a smokescreen about weights and sophisticated leverage rules. That's just nonsense.

Anat Admati: Well, I mean, this is, this was what I thought. So, when I told you my lessons, I told you effectively my deep disappointment that some people would speak up, but many wouldn't. So, when I came in, that was kind of the obvious thing I thought. It's not like it's a silver bullet. We still need to discuss all kinds of disclosure issues and derivatives and other things. And there is, you know, there is a lot of consumer fraud. There is a lot of other things that we can talk about--

Russ Roberts: Sure--

Anat Admati: you know, if we get to corporate governance, especially in this kind of area. But, yeah. And so, I wrote a paper in which I discuss, based on my many experiences engaging with people in various ways, publicly and privately, from across the system--the private sector, the policy sector, the people who did not want to engage, who did want to engage--and what I learned, the paper is called "It Takes a Village to Maintain a Dangerous Financial System." The inspiration of the title was actually at the same time that the movie The Big Short came out. Which ends with a question people want to ask. And, so, if you saw the New York Times 10-year Anniversary Business Section of the Sunday of like, September 15th or 16th this year, it had a blank page for the 10th Lesson. And it had a complete list of all the executives that went to jail, and the entire full page was blank. And it said, 'This page is intentionally blank.' It was very powerful. So, ask why people didn't go to jail, and of course, I'm asking about what was legal. I'm asking--

Russ Roberts: Exactly--

Anat Admati: about. And most of that was described, even in the movie The Big Short, was legal. So, nobody would go to jail for that. And so, even beyond the question of fraud, which we can discuss why, you know, [?], or other people, why there was, seemed to be some evidence of mortgage fraud and others ended up just settling and just moving to comfortable retirement. You know, what was legal was most outrageous. And so then, what's the [?], so it takes a village, in the movie spotlight which came at about the same time, about sexual harassment of the Catholic Church--

Russ Roberts: Sexual abuse--

Anat Admati: Sexual abuse, sorry, abuse. We are talking serious abuse, criminal abuse. In the Catholic Church. In Boston. And then it turned out in many other places where they were recycling these abusive priests. The lawyer tells a reporter, at some point, 'If it takes a village to raise a child'--which is a famous saying, I love Hillary Clinton's old book, It Takes a Village to raise a child: It takes a village to abuse a child. And he meant people looking away. People enabling, you know, if you think now of [?] Weinstein or any kind of wrongdoing that persists, people are not speaking up. Or not of, in history, obviously, atrocities that persisted, you know, with people being afraid sometimes to speak up. But, all this stuff. Well, so why aren't--so, I go through the enablers of the system. The enablers in the private sector, including people inside the firms, the people around the firm, the private watchdogs, the credit-rating agencies, the auditors. All of that. All the way to the policy-makers. To the people in government, the politicians; and then of course the people who have some connection or sometimes are indistinguishable from the policy-makers, and academically[?] like Ben Bernanke and others. And the media. For, you know, the toxic mix of confusion and sort of willful confusion. And I had to go read about, you know, all kinds of terms in psychology: about willful blindness and moral disengagement. And all of those things that allow people to kind of do harm and still feel okay about themselves. And so, you've written to ethics; and it does become ethical. And I gave a talk here at Stanford about lessons from the Crisis in which I quoted extensively from Ken Arrow--who knew from the beginning that this was, the Crisis was a big crisis. Was a big point to ask a lot of questions about the very system, and indeed the very financial system with all these securities that he himself wrote about, back in the 1950s. And I discovered just recently that Ken Arrow wrote an op/ed on October 15th, 2008, called 'Risky Business.' It's saying this presents a challenge to standard economic theory. And, you know, asymmetric information is key precisely in the complex securities that standard theories called for. Which is his theory. And he knew there was a problem right back then. And he then was thinking about ethics. Well, in my ethics, in my enablers, I go to the academics, and I see the kinds of things that I discovered 10 years ago, which is completely false statement in a banking textbook by a big shot named, you know, Mishkin, of all people. False statement. And then a whole slew of misleading and flawed statements and reverse-engineered models. Which I can go on and on about into the night. By experts, academics, with clever models, and all of that, to reverse-engineer somehow why what we see must be good, because we see it. And it's a bias, somehow: What we see must be good. Because we see it. And it's a bias that they have that, you know, somehow, what we see must be good. And it's sort of cultural, sociological attempt to belong, to assist them, because it's more convenient. And, you know, when I stepped into it, somebody said to me, you know, when a policy-maker talks to an academic, they know the answer they want to hear. So they will talk to certain academics that, you know, tell them what they want to hear. And the academic, he said to me, wants to feel important. And so, it was--I from the start call it the Big-Shot-ness syndrome. And, you know, you get rewarded for providing the narratives to people who find it convenient to tell the story in a particular way, such as to start the story from their heroism of saving a system that they were very much part of, and tolerated, before and since. And to basically say, to us, that this system is inherently fragile and we got a foot in place, you know, the ambulance[?], they would allow us to say that next time it implodes.

41:53

Russ Roberts: So, I want to read a quote from a presentation you gave recently. It starts with a quote from Upton Sinclair, and then you have a number of different applications of it. The Upton Sinclair quote:

"It is difficult to get a man to understand something when his salary depends on not understanding it."

Then you write,

It is difficult to get politicians to get a politician to understand something when his campaign contribution depends on understanding it.

And, my footnote to that is that: You know, my cynicism grew after the 2012 election, when Mitt Romney and Barack Obama both had a chance to campaign along some of the lines we've been talking about. They could have spoken out against the current financial system. Mitt Romney could have done it--

Anat Admati: Nobody spoke--

Russ Roberts: Mitt Romney could have done it, because here was his chance to show he wasn't just a rich plutocrat--

Anat Admati: yep--

Russ Roberts: he actually was going to say something that hurt his rich friends. And Obama, who was coming from the Left, could say it because he was going to be representing the little guy and that would have been great. And neither one of them said a word--

Anat Admati: yep, not a word--

Russ Roberts: There was not an issue in that campaign.

Anat Admati: I remember that election very well, because I was writing the book at the time. And it actually--interestingly, I was following who would ever say a word: not in the debate, not any time did it come up at all.

Russ Roberts: It should have been the single biggest issue of the campaign, in my view.

Anat Admati: And it wasn't Sheila Bear[?] wrote a book right around that time, screaming about this. Literally, Sheila Bear's[?] book came right before the election. There was a book by Neil Barofsky about the way that bailouts went, and how much corruption there was, in the way that TARP was managed. And, a few other books of that sort. And of course ours, trying to scream, you know, a bunch of academics. And the academics, you know, there were 20 academics across the board that did sign a petition that, you know, that we sent to the Financial Times, which, by the way, was moved into the "Letters Section." The next quote you were going to, the last quote you were going to read was going to be about the media and their incentive--

Russ Roberts: It's difficult to get a journalist to understand something when his access to the news depends on that understanding.

Anat Admati: Yeah. They have access. That adds--there is a whole layer of incentives there. And our letter was pushed into the Letters Section. And the next day there was a really stupid op-ed by Pandit[?] from City, saying the same nonsense that we debunked on the more minor pages the day before. But anyway--

Russ Roberts: So--

Anat Admati: what I was going to say was that, at the time in 2012, interestingly, the only one who said something about the big banks and unhealthy they are and how there would have to be something done about them was actually Paul Singer, saying that if Romney is elected--

Russ Roberts: A hedge fund manager--

Anat Admati: something about, this is Elliot, you know, vulture[?], the hedge fund guy saying--and he was one of the only people who really spoke. In 2016 there was in the Democratic Party more talk of that, because you had the anger bubbling into, you know, into Bernie Sanders, and Elizabeth Warren and all that. But Trump was speaking about it, too. Only to, you know, to totally fill his Cabinet with the same people.

Russ Roberts: Yeah. So, you know, my joke is that the Republicans and Democrats are the same. They both like to give money to their friends. They just have different friends. But they do have one friend in common, which is the financial sector. So both sides take care of--

Anat Admati: Yes. It's bipartisan [?]. And it's bipartisan opportunity, too. So, you have a situation in which Senator Sherrod Brown, who was among the best on this, teamed up with the no-longer, you know, Senator David Vitter, of all. And you had a Brown-Vitter proposal to end Too Big to Fail in which, before it actually said anything to do, 99 senators unanimously decided, around, I don't know, 2013, 2014, to end Too Big to Fail and end the subsidies of Too Big to Fail. Unanimous. And then Brown and Vitter had a proposal to have 15% equity for the top banks. And it never got discussed. It was bipartisan, from, you know, a Democrat and very right-wing Republican; and they could agree on that.

46:01

Russ Roberts: So, my question is: I want to restate your, I want to riff on your quote. It is difficult to get an economist to understand something when his, ____ what? depends on it? Not understanding it. His ego?

Anat Admati: Oh, well, his--

Russ Roberts: his, or is it--

Anat Admati: big shotness. It could be data--

Russ Roberts: or is it his consulting?

Anat Admati: I tell you--

Russ Roberts: Is it consulting?

Anat Admati: It's some of that, yes. I can tell you that after the original--I sent three, I organized three multisignatory, around 20 academics, letters to Financial Times during 2010, 2011, before going down to write the book for a year and a half. And the second one was related to allowing the banks to pay dividends, which depletes their equity and is just the most outrageous, really, think you could imagine. The equity is already there, and they are paying it out. Which, you know, before--anyway. I organized this, and I called--yeah, I don't want to get personal about naming the person, but I can tell you--

Russ Roberts: Please don't--

Anat Admati: two conversations I had with academics. I'll suppress their names right now. One was to--an academic, a very prestigious colleague who didn't sign the previous but I felt would sign a letter that's very narrow on the payouts of, to shareholders, who I know agrees with it, the statement. And I said, 'Would you sign this letter?' And he said to me, 'Well, I have some paper going with some people from Citi'--I think it was. 'I'll get you somebody else to sign.' I said, 'Thank you. I already have people. I don't need your help'.

Russ Roberts: Yeah.

Anat Admati: Another one, I asked about this who knew for sure what is going on, and knew for sure we were perfectly right. I asked, 'Would you sign this letter?' And, he said, 'Well, I would frame it a little bit differently.' I said, 'Okay. So you write your own letter, then.' Because it was in response to some nonsense that was being said. When he did it.

Russ Roberts: But, we have to face the possibility--

Anat Admati: [?] Even right here: Would Hoenham[?] and, say, perfunctory statements but would not actually--and it was the same, with the, you know, report written by, you know, 15 academics called the Squam Lake that was hawing[?] and humming and making all kinds of really, really, you know, false, misleading statements about a lot of things that we took on in the book and elsewhere. And, they wanted, you know, their book got endorsed by Ben Bernanke, because it was just like, you know, 'We have these minor, little statements that don't go anywhere and don't criticize the system.' And, you know, 'We will only--say this and not that.' And, it's that is not criminal, and nobody goes to jail, as you said, for that. But, you know, the nonsense can live or the things you don't say, you know, don't get you into as much trouble as challenging.

Russ Roberts: I encourage listeners to go back, we'll put a link up to it, with the episode I did with Luigi Zingales on the fact that economists assume everyone is self-interested except for themselves--who are of course--

Anat Admati: Yup. [?] economic capture--

Russ Roberts: who are of course dis[?]--totally objective observers of what's been for the people in the world.

Anat Admati: Yeah. Yeah.

49:37

Russ Roberts: Now, we do have to entertain the possibility, I think, Anat--I mean, you don't, but I do, and I think you should, that we might be wrong. That their objections are legitimate and that the system is not nearly as badly structured as we think it is. So, you said the statement in a textbook is wrong. There are a lot of things in textbooks that are wrong. But, I think the crucial question is--

Anat Admati: ah, heh, heh--

Russ Roberts: Do the people who don't, who are not willing to go to the ramparts, to the barricades--and you know, for me, I'm just a talk show host of sorts, a podcast host who is--I'm not in the halls of power. It's easy--it is easy for me to be critical. And I've often admitted that even though I think the bailouts were a mistake and the ones that preceded it--

Anat Admati: I actually don't agree with that. I don't agree with that. And we are agnostic about the bailouts. We just--you know, we say you shouldn't commit to things that would, you know--we just want to learn the lessons.

Russ Roberts: Fair enough. In which case, did they just00you think that's a chance that "other side," the people who don't want to sign the letter--I'm not a letter-signer, I probably wouldn't have signed it either. Even if I'd agreed with it. But a lot of people would say, 'I don't think that's right.' 'I think there are better ways to get it done'. I think there are better ways--

Anat Admati: I [?] I challenge these people. I said to them, 'Okay, so fine: you don't agree with, uh--'. I mean, I was, you know staffers of the Fed when they kind of were reluctantly kind of meeting. And it was, 'Okay you don't like my solutions.' Ben Bernanke said that there is a Too Big to Fail Problem. So, what's your solution to it? You know, you can tell me all day long that there is--you know, you can find, you know policy-makers that, when they say that these companies can fail without harm, I mean, that's, you know, that defies credibility. And so they, you know, then I say, 'Fine.' You are saying, you know, 'Oh, I'm worried they'll go to shadow banking.' I said, 'Okay, that whole shadow banking is a failure to enforce. So, what do you propose to do?' So, in other words, they can sort of say on Internet consequences and say all these things but they are not proposing things to do. And, by the way, about the wrong textbook and stuff, we are talking about things that we fail students in basic corporate finance for saying. So, when I challenge some of the academics, I said, 'Okay. Wait a minute. Are we teaching something wrong in the standard courses of Finance?' Or, is the banking textbook wrong? And, you know, they would just, like, you know, resign from an advisory board to a trade organization clearing house rather than challenge bank law, being, I mean, sometimes--I mean they just would avoid doing that. So, yeah, I mean, I'm open to engaging with anybody and take the intellectual challenge. No problem. The problem is that, you know, the people just don't have real answers. And then they just walk away. So, I've been very disappointed with the level of engagement of the people who disagree. They just don't engage. Or they just change the subject. Or they just start saying, 'Let's go and estimate the subsidies.' I'm like, 'Why do we estimate the subsidies if we can reduce them and we agree that they are distortive?' Etc. Etc.

52:51

Russ Roberts: So, I have my essay on the Crisis, "Gambling with Other People's Money," is coming out in a book form in January. So I've been forced to think about these issues again. And I decided not to change anything in that book. It was written in 2010. I wrote an introduction with some of the things I've learned. But I haven't learned that much since 2010 I've learned a lot between 2008 and 2010. But one of the challenges you could make of my perspective, and it's the one I've been pushing here--it's, again, very similar to yours: One of the challenges would be: If things are so bad, and if Too Big to Fail is still in place--which I believe it is and you believe it is--Why have we not seen another crisis in 10 years? Ten years seems like a relatively long period of time. Why hasn't this implicit safety net which I think is at the root of the problem, why hasn't it caused another crisis? Is there one that's imminent?

Anat Admati: I will tell you. Look. You can--to me, it's not about a crisis. To me, the system is bad every day. I mean, for example, I think the system is too bloated. And just inefficient. So, it extracts from the rest of the economy for giving us the things that we like. But, there is, the reason to believe that this is not the most productive system we can have: that it just can--so, it doesn't have to go into crisis to see--the crisis is when we see that it's wrong. The crisis is an inflection point. But, the system is unhealthy every single day, because there are loans that are made: there might be too much, there might be loans that are not made. All of these things are invisible about the distortions about this system. So, I think a Crisis is not--a system like this can persist for a long time. And a Crisis is just when, you know, it's as if you are burning your engine driving at 200 mph and you know, you might fall off the cliff, but you might make it, you know, along, just living dangerously. So, I think we just live dangerously. Look, I started the presentation off by Jamie Dimon telling the financial crisis inquiry commission that he told his daughter, who I think was in elementary school, who asked him, you know, 'Daddy, what's a financial crisis?' He said to her, 'It's just stuff that happens every 3, 5, 7, 10 years.' And so now, when I talk about it, I say, 'Oh, it's been 10 years.' So, what is it? Where is it going to come from? And I give these headlines, indeed, that one is about "Seelo [? CLO]" one is about Italy. One is about Cyber Security. You know--July 31st 2017 Financial Times--the sequel to the Financial Crisis is here. Then we have, you know, the Crisis is closer than you think. You know. You are going to have people say the crisis is coming and then they are going to be heroes when it does come. But people are saying that Italy, political crisis, it's financial crisis. This is not just financial crisis just now. So maybe it will come from Italy, from Eurozone, imploding again. Or--

Russ Roberts: What is CLO? Is that what you said?

Anat Admati: CLO is Collateralized Loan Obligations. Which is a close [?] of CDO, Collateralized Debt Obligation. In Finance, you often just change the names. [More to come, 56:02]


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