This Stanford Economist Is Drawing Attention In Powerful Quarters, And It's Freaking Out The Financial Industry

Wall Street is freaking about Stanford economist Anat Admati‘s new book on the future of banking, saying “her ideas are wildly impractical, bad for the American economy and not to be taken seriously,” in a New York Times piece by Binyamin Applebaum.

But they are being taken seriously.

President Obama “invited Admati and five other economists to a private lunch to discuss their ideas.” One of those other five economists was the notorious anti-Wall Streeter Paul Krugman.

In “The Banker’s New Clothes: What’s Wrong With Banking and What to Do About It,” Admati argues (along with coauthor Martin Hellwig) that because banks don’t use their own money, they take greater risks and, as a result, “they keep crashing the economy.

Her solution is to “make banks behave more like other companies by forcing them to reduce sharply their reliance on borrowed money,” according to The Times article. She suggests that “large banks should be required to raise at least 30 per cent of their funding in the form of equity” — which is “six times more than the current average for the largest American banks.”

This solution “would likely make the banking industry more stodgy and less profitable,” according to the article.

Stanley Fischer, vice chairman of the Federal reserve “praised her ‘vigorous campaign,'” and Admati recently “testified for the first time before the Senate Banking Committee.”

However, both members of the banking industry and public officials are pushing back against her work. Even Fischer said that although her arguments “made sense in principle,” the U.S. “was constrained by practicality.”

The government has already “required banks to reduce their reliance on borrowed money by increasing capital standards, which dictate the share of funding that must come from equity,” and “officials worry that larger changes would hamstring American banks, driving businesses both to other kinds of domestic financial firms and to foreign rivals”, according to The Times article.

And banks warn that if the government raises more equity, then the “results would be higher interest rates, less lending and slower economic growth.”

So how do we strike a balance?

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.