The title for this post comes from Stanford business school professor Anat Admati’s “It Takes a Village to Maintain a Dangerous Financial System”.  I wonder if the Economics and Finance professor sees the irony in this title after she spent almost ten years traveling the globe promoting the Committee to Save the Bank’s narrative and agenda by calling for higher bank capital requirements?

A little background is needed here.  I first met Anat in 2009 at a conference hosted by Boston University.  She, along with MIT’s Simon Johnson, took the time to explain to me why higher bank capital requirements were necessary to prevent another financial crisis and end Too Big to Fail.

I listened to their explanation, but felt much like the neurosurgeon who had just had a patient with no training in neurosurgery explain how to operate on their brain. Like the neurosurgeon, I offered up my background to suggest I might know a little something about bank capital (while working for a Too Big to Fail bank, I helped to write what eventually became the Basel I bank capital requirements adopted in the late 1980s).

Next, I pointed out a few issues with bank capital.

Issue 1:  Bank capital is an easily manipulated, meaningless accounting construct.

Bank capital, particularly the equity portion, is an accounting construct.  This makes it easy to manipulate.

Regulators had been manipulating bank capital since the outbreak of the acute phase of the financial crisis in the fall of 2008.  They suspended mark to market on subprime securities.  By suspending mark to market they helped the banks avoid acknowledging the size of the losses on the securities they were holding.  Securities that in 2009 the market was showing were worth dramatically less than the banks paid for them.  Bank regulators also allowed banks to avoid losses by engaging in “extend and pretend”.  Under extend and pretend, the banks advanced funds to borrowers who could never repay their loans and pretend these borrowers are current (think rise of zombie borrowers here).

If banks don’t recognize losses, their capital accounts are meaningless as they are overstated.  At the same time, bank balance sheets are meaningless because they are overstated by the amount of losses the regulators are permitting the bankers to hide.  Dividing two meaningless numbers by each other, does not provide a meaningful number.

So how exactly did championing higher bank capital requirements in 2009 end manipulation of these accounts or make them meaningful again?  It doesn’t.

Issue 2:  Focus on higher bank capital regulations reinforces the financial sector’s control of government Simon Johnson worried about in his Quiet Coup.

Under his Quiet Coup, the financial sector has captured our government and is in a position to block essential reforms.  No place is this more evident that in the actions of the Committee to Save the Banks. [The Committee members were Hank Paulson, Ben Bernanke and Tim Geithner.]

The Committee’s narrative called for higher bank capital levels to shift the market’s focus from what problem loans/securities were on or off the banks’ balance sheets to a story that high bank capital ratios are a sign the banks are healthy.  Of course, this story isn’t true.  In the EU, Dexia showed having high capital ratios isn’t equivalent to being a healthy bank.  It had one of the highest capital ratios in the EU when it was closed.

The entire time the Committee was promoting this narrative, it never made the banks write off their exposures to loans borrowers could never repay or their other dud assets (this pushed the damage from financial crisis out of the financial system and into the real economy – Wall Street referred to this as privatizing gains and socializing losses).  In fact, the Committee favored foaming the runway so banks could recognize their losses over a very long time period.  A decade later, we still have no idea of the real condition of the banks’ balance sheets.

Of course, this was a winning narrative for bankers.  They got paid large bonuses at a time when their banks should have been recognizing losses.

So how exactly did championing higher bank capital requirements in 2009 end the Quiet Coup?  It doesn’t.

Issue 3:  Why do you think you can beat the bank lobbyists?

The argument for higher bank capital requirements faced two huge hurdles.

First, financial regulators were and still are saying their stress tests show the banks are adequately capitalized to withstand financial armageddon.  That strongly suggests a dramatic increase in required capital was a nice thing to have but was unnecessary.

Second, bank capital regulation favors bankers because it is their captive regulators who set the higher capital requirements.  Requirements that regardless of where they are set, banks will subsequently lobby to have lowered.

So how do you expect to beat the bank lobbyists?  Anat’s response was she and Simon went to graduate school and through their professional careers personally know many of the financial regulators.  As a result, they could educate these Economists turned regulators on the need for dramatically higher capital requirements.

Despite my background (see above), I have never felt this was a dumb response.  As proof, for the last decade, every macro economist and most financial journalists I have met have parroted Anat’s call for dramatically higher capital requirements.  Clearly, their message got through to someone.

However, bank lobbyists recognize there is an ongoing process by which higher bank capital requirements are set and this process involves more people than the handful of Economists Anat and Simon could educate.  It involves the elements of government Wall Street had already captured:  Congress and the financial regulators.

Wall Street knows how to sell a story.  For public consumption, they went along with the Committee to Save the Banks’ narrative there should be higher capital requirements.  However, they carefully emphasized, these higher capital requirements should be consistent with the stress test findings.  This story gave Congress and the financial regulators all the room they needed to say they were being responsive to Anat and Simon by raising capital requirements.  After all, the financial regulators raised the requirements even though the stress tests showed the banks didn’t need more capital.

So how exactly did championing dramatically higher bank capital requirements beat the bank lobbyists?  It didn’t.  [It wasn’t a total loss though for Anat.  It resulted in several articles in academic journals, dozens of conference speaking engagements and royalties from selling a book.]

Issue 4:  Why not champion transparency instead?

I pointed out how transparency successfully dealt with each of these issues and was necessary to end the Quiet Coup and make bank capital and its regulation meaningful. For example, without transparency bank capital is a lot like eating chicken soup when you are sick.  It may or may not be helpful.

Anat thanked me for my input.  She then explained she had carefully examined the financial crisis and chosen bank capital as her issue.  She let me know in no uncertain terms the issue of transparency was all mine.

True to her word, Anat never championed transparency.  She relegated the need for transparency to make bank capital relevant to chapter twenty-something in her book.  She seldom, if ever, mentioned transparency in the op-eds and articles she wrote or the presentations she gave.  Nor did she ever take any action that would have raised the visibility of what I was doing to restore transparency across the global financial system.

Which leaves me to conclude as this post’s title suggests the bankers have never had better lobbyists than Anat and Simon!