Capital Ideas Blog


By Hal Weitzman

From: Blog

In this post–financial crisis age, everyone loves to bash bankers. One of the most talked-about general-interest books in the subject in recent years was The Bankers' New Clothes, by Anat Admati of Stanford and Martin Hellwig of the Max Planck Institute in Bonn, which skewered banks for opposing stricter reforms such as hikes to capital requirements.

Although the book's public reception was generally favorable, some economists grumbled that Admati and Hellwig started from a strongly anti-bank view and failed to acknowledge that banks perform a useful function in society—for instance, by turning short-term deposits into long-term loans.  

It might seem ironic to argue that the very institutions that dragged the world into financial chaos in 2008 are necessary for the smooth running of society, yet that idea seems to be the consensus view among top economists, according to the latest Economic Experts Panel from Booth's Initiative on Global Markets. More than 70% of panelists agreed with the proposition, "There is a social value to having institutions that issue liquid liabilities that are backed by illiquid assets," while not a single economist in the 45-strong panel disagreed.

Of course, that doesn't suggest that economists don't think banking reform is necessary. "To do this well requires sufficient risk-absorbing capital," noted Princeton's Markus Brunnermeier, while Yale's Larry Samuelson noted: "Such institutions can also impose social costs. If done well, the benefits outweigh the costs. The trick is to ensure this is the case." 

One dissenting voice missing from the poll is that of Booth finance professor John Cochrane, who proposes that banks' activities should be dramatically curtailed. In a recent paper, (written up in this week's edition of The Economist) he argues that banks should be 100% funded by equity, with only the government allowed to lend, echoing a proposal for "narrow banking" first put forward by University of Chicago economists in the 1930s.

In a graphic novella featured in the Spring 2014 issue of Capital Ideas, Cochrane went further, arguing that banks may even be obsolete, an idea opposed by his colleague Douglas Diamond, whose enduring work on bank runs is pertinent. 

In the IGM poll, their other colleague, Anil Kashyap, highlights the concern that fragility may be hard to banish from the financial system, even if banks are killed off. "Narrow banking is a mistake," he writes. "If we ban this, it will move to the shadow banking system."


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