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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.
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.
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.
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?'
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.
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.
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.
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.
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.
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 cousin of CDO, Collateralized Debt Obligation. In Finance, you often just change the names. And it's the same thing. So, CLO, CDO--they are basically the same. Collateralized Loan Obligations: that's the leveraged loans that I was discussing earlier. And so, you know, risky debt, pay securitized and all of that. And the crisis would come from somewhere we don't know, and we're going to say, 'Ooops, we didn't see it coming.' But I think again, focusing on crisis prevention of loan is not really where my problem is. What I noticed, and we are now running out of time to talk too much about corporate governance, is: Once you have a status where you can't fail, and this is true for a lot of large corporations in other industries, too, kind of the so-called 'too big to jail'--you know, I have only so much legal remedies when you break the law as a large corporation producing things I like--you know, you are above the law. We can't enforce laws on corporations. So we see repeated recidivist corporate fraud or other bad practices. And it can cause serious harm from opiods crisis to, you know, to pollution, to other harms. Which, you know, we are having other violations of other laws, in a corporate context. And so, you know, going back to corporate governance, where I was 10 years ago, and back to your question from the beginning about what has changed, I now think the biggest--we now have to rethink all kind of basic things: Why are we allowing so much anonymity to shell corporations to evade the law? Why are corporations allowed so many rights and so few responsibilities, in general? Why is there no accountability to top people in scandals such as Wells Fargo or others, or indeed, Purdue Pharmaceuticals or other, and nobody ever goes to jail who was complicit or responsible for major harm to other people? So, but for street crime, we incarcerate, you know, a huge fraction of the population. But when you are a corporate executive, you get away with a lot of things.
Russ Roberts: Yeah--well, that's a much bigger issue, as you pointed out.
Russ Roberts: Let me raise--and it is a concern, and it's a fascinating question to me of tradeoffs--of, as you say, 'They give us what we like.' And I would say, more or less. Sometimes they give us some things we don't like--
Anat Admati: Right. Yep--
Russ Roberts: But I want to--
Anat Admati: Or dictate things.
Russ Roberts: Yeah. Well, 'dictate things' are tougher issues for me; I'm a big believer in personal responsibility. But, they were, some of those things were--
Anat Admati: But people don't know. You know, people didn't know how addictive opioids were.
Russ Roberts: Right. Well, they were sold in ways--
Anat Admati: [?] They had the information; they [?] the FDA [Federal Drug Administration]--
Russ Roberts: Again, as--
Anat Admati: So, it's an information problem.
Russ Roberts: Well, we did a phenomenal interview with Sam Quinones on Dreamland, his book. And I encourage people to read that book; and I'll put a link up to the episode as well.
Russ Roberts: But I want to close with another criticism I sometimes get of my work, and I'm curious if you agree with it and whether it applies to your work. Which is: 'Look, all these stories about what caused the crisis: The fact is, people are just irrational. There's going to be bubbles in financial decision-making because people get exuberant, and irrationally exuberant,' and, 'You don't need Too Big to Fail. You don't need any of these leverage issues to explain why sometimes financial markets blow up, so don't oversell that.' What's your reaction to that?
Anat Admati: Well, I mean, you just gave the example of the Internet Bubble. I actually think that, you know, I give students--during the Internet Bubble, I was teaching in a business school, and we were asked, 'How come, you know, they are worth so much without earnings?' or sometimes with tiny bit of earnings? And we did an exercise of, you know, fortunately we chose e-Bay, which is sort of still around, and to try to rationalize the huge, you know, e-Bay selling for $130 dollars with $0.08--8 cents--of earnings--you know, what does it take for growth projection, all that. And you know, it wasn't--it was just very sensitive to assumptions. You know, if you project dividends to the end of time, even if you do not paying dividends for the next 10 years, what the cash flow would be in perpetuity. And people, you know, can make mistakes about that honestly in terms of just assessing uncertainty for the future. So, yes. I mean, obviously, assessing the future is difficult. And, you know, I'm from the field of finance, so I know, and I've worked on Information and how it gets into prices and all that early in my career. So, I appreciate, you know, the stories about bubbles and mistakes and all of that. But then, we go back to, you know, protecting from the unknown unknowns, and how easy and obvious that is to do in the context of financial markets. You know, to say, 'Oh, there's going to be exuberance,' what the exuberance is, in the context of these financial institutions, is, is based on people's compensation structures. And in a chapter of our book that's called 'Paid to Gamble,' and to your 'gambling with other people's money.' And in the last chapter it's called 'Other People's Money,' which is about governance in general. And everybody just being loose with other people's money, and irresponsible, which is sort of a fundamental governance problem of the lack of trust. And so, the issue is: You can--all of these things are true, and may be true, and maybe doesn't change the fact that we don't have to suffer so much from these financial fragilities. That, they are--you know, because a few people benefit from them and all the rest are harmed. And the markets are failing to fix that. And therefore we need good, simple rules that would make a system kind of correct the market failures and protect us from this recklessness, and so, you know, it's all no problem for what I'm saying.
Russ Roberts: I wouldn't call it a market failure. I'd call it a government failure.
Anat Admati: Well, I mean, it's a market failure in that you put depositors in with bankers. And the depositors, you know, the market for the kind of contracts that depositors want, you know, is failing: the depositors are unable to monitor the bankers. And they, they are fragmented and dispersed, and the banker has incentives to harm them. And they get away with harming them. And the outcome is inefficient. So, the last paper just said, 'Laissez faire banking is fundamentally inefficient.' And that the government can help by creating effective commitment and taking the role of like a debt governance for the depositors, which don't have good contracts for that. We just want to have the money in the ATM [Automatic Teller Machine]. So, you can make a system more efficient when it can't kind of create the right commitments, or the issue is just the ability to commit through contracts and through markets. Markets do fail in banking. Banking is just, you know, to create an efficient outcome basically.
Russ Roberts: But, my point is that--maybe you don't agree with me--but that many of the problems that we've been talking about are the intervention--
Anat Admati: yeah--
Russ Roberts: of government within the reward system that would exist in a market, in a real market--
Anat Admati: The original safety nets were meant to create stability. Okay. You created Central Bank to prevent pure inequality promise[?] from taking down a bank. Okay. Pure panic. Okay. So, now they have liquidity support. We connected all these safety nets because the system was too fragile on its own. But now that we've created the safety nets, we forgot to accompany them with a correction to counter the even worse incentives that they create, that the safety nets create. So, my solution is: Yes, you can have safety nets to a point. But then you have to make an efficient, effective, you know, counter to the incentives that get created. Some of these incentives would be there with laissez faire, and these incentives get only worse when we try to fix the system with these interventions that you don't like. So, I--my position is a little more nuanced, therefore. I say that, you know, to a point, you want, you know, the government to, you know, do, to provide certain things and certain protections. And then, at the same time to not allow the abuse of those systems. And that's what you definite--what banking needs. Instead what you have is the politics only distorted further. So, you know--and when we do--and I speak to that in my slides, which are all public and I can send you links to a lot of them--I summarize the politics of banking, which is where the politicians see banks as a source of funding for whatever it is they like and not a social risk. You know, 'Banks are where the money is,' as the robber said, when asked why they robbed the bank. It's a kind of lame joke, but it's very deep--
Russ Roberts: It's Willie Sutton's line, and he was onto something. My guest today has been Anat Admati; and thanks for being part of EconTalk.
Anat Admati: Thank you very much.