Anat Admati on How to Never Bail Out Banks Again

Tracy Alloway (0:02)

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Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:22)

And I'm Joe Weisenthal.

Tracy Alloway (0:23)

Joe, it is coming up to the one year anniversary of last year's banking drama. I'm still not sure if we can call it a crisis or not.

It kind of felt crisis-y at the time.

Joe Weisenthal (0:35)

But it went away so fast. You know what the funny thing was, and I probably mentioned it, is there was that cliche, or I don't know, thing that people say, the Fed is gonna keep hiking rates until something breaks.

It's like, here's the break, it happened. And then it was like a blip, it's like nothing. And then the Fed kept hiking and stocks kept going up and everyone forgot about it. So it was kind of weird that something that dramatic could happen and seemingly then just sort of get forgotten about kind of quickly.

Tracy Alloway (0:59)

Well, one of the most dramatic things that happened out of all of that, I thought, was when they basically just guaranteed everyone's deposits, right? So we know at this point that you are supposed to have up to $250,000 of your deposits at any bank or any bank that's FDIC guaranteed.

Basically, those are safe. If the bank goes under, you get that money back. But then we saw that Silicon Valley Bank went under and people had more than $250,000 in their accounts and they got bailed out, which is kind of phenomenal. I don't think we talk about the deposit guarantee aspect of that whole thing enough.

Joe Weisenthal (1:39)

We talked about it at the time.

And I think this was the interesting thing. And you're right. This is the sort of the bigger thing that has been slipped under the rug, which is if all deposits in all US banks are implicitly federally backed, then do we need to rethink the business of banking? If this huge source of finance, if it's all guaranteed in the end, then it's like, why do we allow these banks to operate as they are?

That was a big question. We talked about it in March and April and May, and that's still unresolved, but people have really moved on from that question. But it really is fundamental.

Tracy Alloway (2:12)

Not us. We are still living in spring of 2023 So I'm very pleased to say we do in fact have the perfect guests to discuss this. You might remember we spoke with Stephen Kelly a couple weeks ago about how the way we're bailing out banks or supporting them with various liquidity facilities is changing. In this episode, we are going to be focusing on getting to a point where you don't actually have to bail out the banks. Let's just avoid this problem altogether.

And I'm very pleased to say with us now we have Anat Admati. She is of course an economist and professor at the Stanford Graduate School of Business. She has written prolifically on this topic for at least as long as I can remember at this point, certainly since the 2008 financial crisis.

Anat, thank you so much for coming on Odd Lots.

Anat Admati (2:59)

Thank you so much for having me.

Tracy Alloway (3:01)

We needled Stephen a little bit when he was on the show by just throwing out...

Anat Admati (3:06)

Equity or solvency.

Tracy Alloway (3:08)

So I'm going to do the equivalent for you and say, how do banks hold capital?

Anat Admati (3:15)

Oh my God, that word is a trigger because that word leads to so much confusion. So I'm glad you started with that. A senator would say it's money on the sideline. Newspaper articles explain it as cash like asset, and it's not true.

What we're talking about this hold capital is not something that actually the banks hold, it's something that investors hold. In fact, what they do hold is those reserves in the central bank on which they get 5.4%. That's what they hold. That's what's out of the economy set aside.

What we're talking about is just like deposits on the funding side, we're talking about equity funding for banks. An amazing idea in banking that you would actually need any of it. And guess what? They live like no corporation lives and no corporation needs to live. But they're there because I have a lot of research on leverage and leverage addiction. And it's just they are at the point of such heavy indebtedness that they hate coming out.

Joe Weisenthal (4:16)

So when people think banks need to have more capital or hold more capital, in their mind, what they hear is, banks just need to have more cash set aside for an emergency.