When Simon Johnson and John Cochrane agree on a matter of regulatory policy, it’s time to pay attention. And they’re both highly recommending a new book by Anat Admati and Martin Hellwig called The Bankers’ New Clothes that argues that banks should be made to finance their lending with a much higher level of equity and a much lower level of debt than is current practice. They say bankers’ argument that this would be a socially costly step is completely mistaken and we could get a safer financial system here at no real cost.
I haven’t finished the book yet, but I’ve enjoyed what I’ve read so far. More importantly, I’ve read Douglas Elliott’s argument that they’re understating the costs involved here, and I’m comfortable with their conclusion anyway. If I have any concern with the argument, it’s more that I worry they may be overselling the upside in terms of how much safer this step would really make the financial system, but I’ll refrain from further comment until I’ve finished the book. For now, let me just say that I think this will be an important next frontier in the debate over bank regulation. I don’t think I know anyone who seriously believes that Basel III and Dodd-Frank are going to be the end of banking crises, and that means more opportunities will arise to get different regulatory ideas on the agenda.