le 16 juin 2013
The two authors "prove" that one of main causes of economic crises is the motivation of the bankers. It is not their intention. They are "blind" to the disconnect between their actions and their intentions leading to regular crisis with high levels of unemployment and large-scale reduction of prosperity.
The reason why this is so is very simple once you understand it. You have to read the book carefully because banking lobbyists make an enormous effort to complicate and confuse the issues. The authors explain in minute detail how they have arrived at their conclusions. One author is an American professor from Stanford University and the other the German director of a Max Planck Institute. Both are world level experts on this issue.
The simple answer is that Bankers try to keep the shareholder equity (cash paid by investors when the company sold shares and retained earnings, profits that were not paid out as dividends) as low as they can by preventing a regulation that would impose a thirty percent ratio between equity and total assets (the "capital ratio"). You need to understand what exactly are "real" assets and "real" equity, which is different in this book from the way bankers refer to these words. Understanding this difference is essential for understanding the message of this book.
Why are bankers motivated to minimize shareholder equity? They aim to maximize Return on Equity (ROE). This is the ratio between profit and equity. It is obvious that with the same profit and a lower equity the ROE increases. According to the authors, the total income of the senior bankers is in most banks based, to a large extent, on this ROE. This is illustrated by a statement of Bob Diamond when CEO of Barclays in 2011, "Barclays is counting in being able to fund part of its capital requirements with new contingent convertible instruments or co cos, which will not dilute ROE numbers."
Bankers argue that increasing equity is not of interest oh the public at large because it will reduce liquidity, reduce the amount of financing, increase the interest rates they have to charge, and refer to the "level playing field" where other countries accept lower equity levels and increase their costs unnecessarily.
The authors go into immense detail to prove that all these arguments are false and why this 30% ratio will radically reduce financial crisis, avoid bail outs and radically reduce the motivation of bankers to take excessive risks, earlier write down non-performing loans performing loans, will continue to award loans to small companies, even in a down turn and no longer search and develop risky innovations to increase bank profits. They also explain, again in detail, why Basel III, which deals with this issue, has been watered down to the point that the financial system to day and still after its implementation will as fragile as it was in 2007.
Why do governments not impose this 30% rule? The authors refer to the lobbying power of banks and their associations with as an example the statement of Jamie Dimon CEO of JM Morgan Chase (JPMC): " JPMC gets "a good return on the company’s seventh line of business"-government relations." The authors also show that the capital ratio of JPMC with a "Fortress Balance Sheet" is 4.5% under international accounting rules and would still be considerably lower considering that total value of JPM in the stock market on December 30 2011 was 58 billion less that the shareholder equity in the accounts. The authors describe bankers' attitude as "Anything but equity" and "It very hard to get a person to understand a truth if understanding it would lead to a reduction in her or his income." The authors claim that increasing shareholder equity for successful companies is "easy" by issuing shares and/or not paying dividends until the 30% is reached.
The authors have tried in their important public activities and publications to convince governments to act and as they failed have published this book