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The crusade for capital

What Al Gore’s An Inconvenient Truth did for public awareness of global warming, Anat Admati’s forthcoming book aims to do with the neglected issue of bank capital. The Stanford University professor of finance and economics currently is refining a forthcoming book, titled “The Banker’s New Clothes: What’s Wrong with Banking and What to Do About It,” with co-author Martin Hellwig. Admati hopes to inform public citizens and their elected Washington representatives about a basic concept that banks wish to obscure.

Bank capital and global warming are connected. Former Vice President Gore made approachable the foreboding statistics linking human industry with planetary warming. Congress approved some global warming measures in the summer of 2008, but that effort ceased in September, 2008. Why? Because Wall Street’s implosion and the subsequent economic crisis that resulted supplanted all other issues, including global warming.

Congress responded to the financial crash. Among the reforms Congress passed were requirements for increasing capital for banks. This central safeguard should ensure that banks are able to cover their own losses when they make mistakes, thus preventing any need for future taxpayer bailouts. To date, however, proposed increases have been so miniscule as to be meaningless.

Admati believes lawmakers and the general public misunderstand this critical measure. Her book “The Bankers New Clothes,” aims to inform the taxpayers who financed the bailout of what is needed to prevent another one.

In banking, the term “capital” refers to the amount of money that is invested in a bank. This investment money joins money that the bank borrows. Borrowed money comes from depositors and other lenders. (Yes, when you deposit money in a bank, you are loaning the bank money.) The bank then deploys both types of money together in loans. If a loan is not repaid, the investor absorbs the loss first. Only after all the investor money is lost does the bank begin to renege on what it owes the creditors (you as the depositor and others) that loaned it money.

The Wall Street bailout that Congress approved in September 2008 replenished investor money—capital—for the nation’s largest banks after it became clear their mortgage loans were rotten. No depositor lost money. No creditor, such as a bank bondholder, lost money either. But Congress approved a taxpayer bailout these creditors because the banks weren’t holding enough investor money to absorb the loss.

Instead of another taxpayer bailout, Admati and many other financial policy experts (who tellingly are not on Wall Street’s payroll) call for far greater investor capital as a percentage of the bank’s total loan portfolio. By some measures, the largest banks currently have only about 3 percent in investor capital; the other 97 percent is borrowed. That’s not much room for mistakes before a large bank needs another taxpayer handout. Admati calls for banks to have more than 20 percent.

What many misunderstand is that bank capital is NOT a cookie jar of cash protected in a vault. Raising bank capital requirements does NOT reduce bank lending. Rather, it simply requires a bank to deploy more investor dollars with each loan.

Does a higher capital requirement mean a recipe for business stagnation? No. As Professor Admati said to the House financial services committee in testimony on November 29, consider Apple Computer. One of the most successful businesses in the world, the company risks billions of dollars in research on new products. Each one of these dollars comes from investors. The “capital” in Apple hardly sits idle.

Wall Street lobbyists profit from the misunderstanding that capital is somehow wasted or idle money. As any gambler knows, it’s better to bet with borrowed money; creditors only get their loan back, not a share of the winnings. And, because of the 2008 bailouts and the ongoing failure to break up the “too big to fail” titans, mega-banks trust that their losses will be covered by Uncle Sam. Wall Street has successfully won the battle of metaphor; even Federal Reserve Chairman Ben Bernanke talks about banks “holding” capital.

Pushing back on Wall Street’s metaphor isn’t Admati’s only goal with her forthcoming book, but if 535 members of Congress could properly define bank capital, we could go a long way towards implementing proper reform. Perhaps then Wall Street could be safely neglected, allowing the nation to save the rest of the world from global warming, war, famines, etc.

Bartlett Naylor is Public Citizen’s financial policy reform advocate. You can follow him at @BartNaylor.

To learn more about Public Citizen’s financial reform work, visit citizen.org/financial-reform.