One possible way to make big banks safer — in addition to downsizing them and/or restructuring them to eliminate government’s TBTF subsidy — is by making them fund their loans with more unborrowed money — equity capital. Banks may only have 1% to 3% equity capital relative to the overall assets. Some economists think 20% or 30% might be what’s needed.
Bankers tend to not like this idea at all. They argue holding more equity capital would increase funding costs, lower return on equity, and force them to cut back on lending. Not so, argue Anat Admati and Martin Hellwig in The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It out later this month. The above table outlines Admati and Hellwig’s responses to typical banker objections.
Most the ideas banks and business suggest have an element of Red Herring contained within so you know that they are giving you boilerplate rhetoric to cover the simple business creed: maximize profits is the first and only self-imposed rule of business! Taken to excess is wherein the problem lays. This is why we need regulations to protect the average consumer and the economic system from the ever emerging bubbles!
Of course they should have a lot more capital. Most of the ‘banks’ that I see look a lot more like hedge funds and take huge risks because their funding costs are artificially low. Let the markets work and the issues will take care of themselves. But to do that you have to allow competition for the Fed and that will not happen until there is a serious crisis.
“Should banks hold a lot more equity capital?“…
Define a ‘lot more‘?
50% of their outstanding loans?
More?
Less?