Welcome to our video series called "New Economic Thinking." The series will feature dozens of conversations with leading economists on the most important issues facing economics and the global economy today.
This episode features Anat Admati, author of The Bankers' New Clothes: Whats Wrong with Banking and What to Do about It, talking about how to fix our broken banking sector. Admati debunks many of the myths and misunderstandings that plague the debate on financial reform and makes the case for how we can make finance work for the rest of the economy, rather than the other way around. Below is an introduction written by Admati. Watch the interview to see what she has to say about why current regulation fails and why the financial sector urgently needs to change!
Why does the financial system remain so reckless?
The answer lies in what can be called “the political economy of flawed claims,” a toxic combination of entrenched, self-serving banking myths and the politics of banking. As a result, key issues are greatly misunderstood, and essential regulations to counter the harmful forces at play have not been put into place.
Misunderstandings and politics give these myths a persistent staying power that has proved harmful. To explain the issues to a broader audience, refocus the debate, and push the resistant policymakers towards more effective and highly beneficial reform, Martin Hellwig and I wrote, The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It. (“The Bankers’ New Clothes” refers to flawed claims made in the context of banking, not just by bankers but by many others.) The book argues that we can and must address the dangers and distortions that the financial sector imposes on the rest of the economy so it can work better within the economy. It also debunks many flawed claims that have managed to hijack the debate.
Academic research in banking has contributed to the problem. This research often presumes that the system we have is inevitable or essential and seeks to “explain” what we see as useful, presuming that markets work when in fact they fail. Salient forces in the real world are conveniently ignored.
In particular, as Charles Goodhart stated in his “New Economic Thinking” interview, models in banking and macroeconomics routinely ignore the inefficiencies of distress, insolvency and default, moral hazard problems, and corporate governance, as if they do not exist in banking. Economists choose to ignore the “big elephant in the room,” the intense conflicts of interest that are rooted in the fundamental borrower/creditor conflict that translates to a conflict between bankers and society regarding risks and how the upside and downside are experienced. As a result, economists have significant gaps or “blind spots” in understanding the financial system and its interaction with the economy. Rob Johnson and I discussed this political economy problem in a conversation recorded in February 2013 when the book came out.
The politics of banking also has been emphasized by Simon Johnson. The intellectual capture comes about in part because of what those involved in the debate (possibly including bankers themselves) know or understand, and what they want to understand or choose to believe. A barrage of flawed research produced by bank lobbyists, regulatory bodies, and academics provides cover to flawed policies, muddles the debate, and offers more convenient narratives that work better for those involved. It is a case of willful blindness – or worse.
Some material left out of the book that touches on some of the academic debate is included in this “omitted chapter.” Additional insights on the real economic forces are available in a revised academic paper titled “The Leverage Ratchet Effect.” (This paper is a revision of the paper on debt overhang and deleveraging that I presented at the Institute for New Economic Thinking’s Berlin conference in 2012.)
Unfortunately, publishing the book has not stopped the continued nonsense. Those who prefer the flawed narratives mischaracterize, dismiss, or ignore what we actually say. To counter this, and because it takes the time to read and process the many issues, Martin Hellwig and I also wrote a brief summary called “The Parade of Bankers’ New Clothes Continues: 23 Flawed Claims Debunked.” For more materials and links, see the book website.
I was told back in 2010 when I entered this debate that I will be “in good shape after the next financial crisis.” But, especially in Europe, we are still not yet out of the previous crisis, and urgent action is needed, as we outline in a chapter entitled “If not now, when?”. The unhealthy banking system remains a drag on the economy even without a full-blown crisis. I still hope more is done to prevent it from inflicting more harm on so many.