The liquidity and solvency constraints
on the banker are peculiarly tight. They have to hold some liquid assets and they cannot survive
a substantial fall in the value of assets. The reason is because… banks issue liabilities, they’re extremely liquid and they have very little equity. Banks have very little equity. You look at a bank balance sheet. On the asset side they have some government bonds, okay. They have some reserves. These are their liquid assets. They can use these to meet withdrawals and clearing with other banks. And then they have loans. On their liability side they have demand deposits, savings deposits and then net worth. Okay, this is a simple balance sheet. Today banks have lots of other stuff, okay The net worth is let’s say 5%. The
deposits total 95%. Let’s say that the loans are 80%, okay. Losses here have to be covered out of here. So you see they cannot lose very much on their loans without wiping out their equity. Banks operate very little of their own money at risk. Mostly it’s other people’s money at risk. Other people’s assets are at risk, okay. So the value of their assets, if the total value of their assets falls by 5%, they have wiped out all of the equity. The net worth is now zero, okay. Now these are safe. They’re not going to go down. It’s the loans that are the problem. A relatively small loss on the loans wipes out all the equity. The banking regulators and supervisors will maintain
some minimum that they accept. And it’s not going to be zero, okay? If this bank lost only two percent on
its loans which not… these are not huge losses, they lose two percent on their loans, their net worth is falling to three. The regulators would discover that. They would say you must increase your equity. {Or I shut you down?} Or we’ll shut you down. We’re going to take control of your bank, okay? At something like 3% {And this happens frequently?} This happens every day of the week in the United States. {With small banks?} With small banks. {And with big banks?} With big banks it is extend and pretend. {No, I don’t understand} Extend and pretend says… We’re going to give you an extension to try to increase your equity and we’re going to pretend
like you’re safe. Okay? The big banks… In 2008 my guess is every big bank was negative net worth, not zero, negative. Massively negative, {So} Massively insolvent. And we’re gonna go like this. And hope everything’s okay. {And so, let’s say, this is just a political choice} {technically if they want to treat the big
bank as they treat the small bank they could} {there’s no technical limits just a political choice} Absolutely. They could step in. They don’t. They don’t have to shut them down. They have to take control of them. In the Great Depression what was probably half of the banks were in some difficulty and Roosevelt choose a guy named Jesse Jones. Great name! He went in. He required all the top management of every bank that they took control of, to
submit resignation letters. Jesse Jones says, “I’m going to keep this in the drawer. I might
not accept it right now. I’ll keep it in the drawer to give you a
chance but if you don’t change the way you’re behaving, I’m gonna pull that out and you’re fired”. He would accept the resignations. But for a lot of the banks he did accept the resignation immediately, replaced the top management with people he trusted. So yes you can do that. It could have been done. {Many times in the mainstream media they give this idea that banks are controlling the state or they
are more powerful than the state and this just showed actually it never should be like this because actually the regulator technically can always regulate banks} Well but {technically, not politically, technically} they probably were controlling the state and therefore the regulators did not manage it. In the film last night, I can’t remember who it was who said that for a long time the politicians were choosing
regulators who oppose regulation and this is absolutely true. So if you choose regulators who oppose
regulation, surprise, surprise, they don’t do a good job of regulating. {Paul Krugman said it} Okay, Krugman. And this was true. When I graduated one of my fellow students went to work at the SEC. And
this guy was much more free market than me. He wasn’t a big fan of regulations but he actually quit because he said, “You know what? I’m working in a place that’s supposed to be regulating and everybody above me is opposed to regulations so we can’t do our jobs”. This is during the year, the era, of Rob Wayne. So anyway, it does make a difference, what kind of regulation you have.