[财经英语角区] Love the Bank, Hate the Banker [推广有奖]

Public discourse is rarely nuanced. The public’s attention span is short,and subtleties tend to confuse.Better to take a clear, albeit incorrect, position, for at least the messagegets through. The sharper and shriller it is, the more likely it is to capture the public’sattention, be repeated, and frame the terms of debate.
Consider, for example, the debate about bank regulation.Bankers are widely reviledtoday. But banking is also mystifying.So any critic who has the intellectual heft to clear away the smokescreen that bankers have laid around their business, andcan portray bankers as both incompetentand malevolent,finds a ready audience. The critic’s message – that banks need to be cut downto size – resonates widely.
Bankers can, of course, ignore their critics and thepublic, and use their money to lobby in the right quarters to maintain theirprivileges. But, every once in a while, a banker, tired of being portrayed as arogue, lashes out. He (it isusually a man) warns the public that even the most moderate regulations placedon banks will bring about the end of civilization as we know it. And so the shrillness continues,with the public no wiser for it.
A more specific example drives home the point. A significant number ofbanks operated at very high levels of leverage prior to the recent crisis, withdebt/equity ratios of 30-1 (or more) in some cases, and with much of the debtvery short-term. One might reasonably conclude that banks operated with toolittle equity capital, and too little margin of safety, and that a reasonableregulatory response would be to require that banks be better capitalized.
But this is where the consensus breaks down. The critics want banks tooperate with far less leverage, especially regarding short-term borrowing;indeed, some want all-equity banks, so that the system becomes safe. Thebankers retort thatthey must pay a higher return on any additional equity that they issue, so thatmore equity would increase their cost of capital, forcing them to raiseinterest rates on the loans they make, which would reduce economic activity.
Neither side is quite right in their public arguments. Thebankers do not seem to have internalized a fundamental axiom of modern finance: risk emanates from the assetsthat a bank holds. According to the Modigliani-Miller theorem, the mix of debtand equity that it uses to finance its assets does not alter its average costof financing. Use more “cheap” debt, and equity becomes riskier and costlier,keeping overall financing costs the same. Use more equity, and equity becomesless leveraged and less risky, which causes investors to demand lower returnsto hold it, and again the overall financing cost remains the same. Putdifferently, given a set of cash flows from a bank’s assets, the bank’s valueis not affected by how those cash flows are distributed among investors, somore leverage does not reduce the bank’s cost of funding.
If their public argument is incorrect (and they must knowit), why do bankers prefer short-term borrowing to long-term equity finance?The critics would say that it is because of the tax preference accorded todebt, or because banks are too big to fail.
But these arguments do not withstand scrutiny. If the tax deductibility of interestmade debt attractive, then bankers should be indifferent between long-term debtand short-term debt. Yet they seem to prefer the latter.
Similarly, too-big-to-fail banks would not care about thefailure risk associated with debt financing. But, again, it is unclear why theyshould prefer short-term debt. After all, if bankers were trying to benefit,would they not issue long-term debt, for which the default risk, and the gainfrom the implicit government guarantee, is high? Furthermore, why do smallbanks, which have no implicit backing from the government, also have so muchleverage?
The critics’ arguments about the benefits of equity areequally unsatisfying. Of course, given a set of bank assets, more equity wouldreduce the risk of failure. But failure is not always a bad thing; a bankeroperating an all-equity bank, with no need ever to repay investors, would belikelier to take unwarranted risk. The need to repay or roll over debt imposesdiscipline, giving the banker a stronger incentive to manage risk carefully.
For example, when Washington Mutual collapsed in 2008,following an uncontrolled lending spree (it was the largest bank failure in American history), itwas not because equity holders decided to close it down, but because depositorsdid not trust it anymore. How much more value would Washington Mutual’smanagement have destroyed if the bank had been all-equity financed?
In sum, there are tradeoffs. Too much short-term debt makesbanks more prone to failure, while too much equity places little restraint onbankers’ capacity to destroy value. The truth lies somewhere between thepositions of today’s strident critics and indignant bankers, which may be whythe moderately leveraged bank has been a feature of Western economies for athousand years. Our distaste for the banker must not be allowed to destroy thebank.