(Re-live) Short Cut with Martin Hellwig and Martin Wolf: On Dangerous Banks and Political Power

Along with the housing bubble, the global financial crisis of 2008 shattered the liberal dream of efficient financial markets. Since then, stricter rules have been introduced to prevent taxpayers from having to pay for bank bailouts. But in reality, little has changed, write Martin Hellwig and Anat Admati in the recently published expanded edition of their book “The Bankers’ New Clothes: What’s Wrong with Banking and What to do about it“. The book was originally conceived in 2013 to demystify the complexities of banking for a wider audience. The updated new edition, which adds four chapters, peels back the layers of global finance and lobbying and reveals why the major banking reforms promised after the financial crisis have still not materialised.

We invited Martin Hellwig to discuss the extended version of his and Admati’s book as part of our New Economy Short Cut series together with Financial Times chief commentator Martin Wolf. Why have the promised big reforms of the banks failed to materialise after the financial crisis – and what would be needed to make the system more robust?

Hellwig highlighted how the entrenched narrative of the banking lobby, which portrays regulation and high capital requirements as perpetually burdensome, has thwarted substantive reform efforts. Despite pledges to rein in excesses after 2008, banks have swelled in size and power, shielded by the specter of ‘too big to fail’ and hampered by problems of cross-border coordination between regulators and a deliberate tolerance of malpractice. Recent crisis cases such as Credit Suisse and Silicon Valley Bank underline the missed opportunity to overhaul a system that flirts with collapse, fuelling public distrust and the rise of populist sentiment.

Martin Wolf underscored the gravity of public liabilities in an era where the onus falls on taxpayers. The age-old saying, “if you owe the bank a hundred dollars, you have a problem; if you owe the bank a hundred million, the bank has a problem,” takes on new resonance in an era where the public purse bears the burden of trillion-dollar liabilities.

While potential remedies, such as the Admati-Hellwig plan and the Chicago plan*, offer theoretical promise, Wolf believes that entrenched political interests impede substantive change. The banking sector wields significant political influence, arguing that banks are too vital to fail due to their pivotal role as sources of credit and money. The public, regardless of depositor wealth, fears bank failures, prompting governmental and central bank interventions and deposit insurance rules. However, the political economy of banking perpetuates an open-ended subsidy to bankers, where new rules introduced post-crisis are gradually eroded, as bankers adeptly argue for exceptions.

The sobering conclusion was that failure to bring about systemic change portends deeper economic turmoil on the horizon.

* the Admati-Hellwig approach wants to treat banks as normal private companies and strip them of their implicit subsidies; the Chicago plan proposes to make liquid monetary liabilities safer by backing them up with unimpeachably liquid assets.