yogi berra on leverage

Professor Anat Admati, one of the distinguished economists who were recently widely noted as calling the bluff on bank CEO assertions about the negative effects of stricter capital requirements, has written a letter addressing the nonsense touted in the Financial Times by such bankers and their supporters. Since many readers will not have access to the proprietary material at the Financial Times, I thought you would enjoy seeing her letter here (republished with Professor Admati’s permission) and at the following link:

Highly Leveraged Banks Inflict Great Suffering on Society
Text of Letter published in Financial Times, December 2, 2010

Anat Admati
George G.C. Parker Professor of Finance and Economics
Graduate School of Business
Stanford University

David Miles’ column (“Banks fail to convince crying foul over Basel reforms”, November 24) and his follow up letter (“Don’t dismiss Modigliani and Miller logic on bank funding,” November 30) in response to letters by Messrs Barwell, Gleeson and Samuels on November 29, were refreshing, particularly following Citi CEO Vikram Pandit’s previous comment (“We must rethink Basel or growth will suffer,” November 10).
Unlike Pandit and the November 29 letter writers, Miles focused on the logical arguments. Mr. Samuels used a quote by baseball star Yogi Berra to dismiss Miles arguments as theoretical and inapplicable to practice. But Yogi Berra is also famous for instructing a waiter to cut his pizza into six slices because he is “not hungry enough for eight slices.” This is funny precisely because the size of a given pie doesn’t depend on how many slices it is cut into, an exact analog to Modigliani and Miller’s result.
This is true in theory and no less true in practice. The reason that high leverage lowers banks’ funding costs is that the more debt banks use relative to equity in their funding, the smaller is the slice the government takes in taxes, and the higher is the value of the implicit or explicit guarantees the government provides to their debt.
Highly leveraged banks, particularly those too important to fail, have strong incentives to take on excessive risk, enjoying the upside without having to worry about the downside of their bets. Given the fragility and systemic risk that high bank leverage entails in our interconnected financial system, society suffers greatly when banks are highly leveraged, even as banks and their managers benefit. When it comes to banks and their leverage, there are no practical considerations associated with bank funding that provide any reason for the public to allow banks to be anywhere near as highly leveraged as they would like to be.
Messrs Pandit, Barwell, Gleeson and Samuels must do more than dismiss arguments as theoretical and raise vague and unsubstantiated threats to global growth and the economy. They must explain precisely what forces should lead society away from imposing high equity requirements on banks and how such an effect comes about. Unless and until they do so, it is their arguments that should be dismissed and not Miles’.

6 comments for “yogi berra on leverage

  1. December 4, 2010 at 6:43 am

    Terrifically written post. Yogi was quite a guy. I always wondered if Yogi had a semi-version of autism or something. He was just different. But seems he was always honest and humorous.

    I like the link to Admati, and appreciate it. Admati is obviously a clever guy. One thing when I write about these things, (usually in smart-aleck comments on others’ blogs) I always try to word it “too systemically threatening to fail”. I notice you worded it “to important to fail”, and in my opinion for the “layman” to important to fail doesn’t quite get the idea they need to have clarified. That idea is that this is closely related to the size of the banks, and also that “Leverage” or “credit” is just a nice way to say debt. And although high levels of debt benefit banks’ profit margins in good times, and lower their tax rates, this higher debt ratio is “systemically threatening”. And more importantly the high debt level for banks is a constant source of systemic threat to the system, even in good times, when that threat is often not recognized, but is nonetheless there.

    I think you (Professor Baxter) clearly know that already–but to the reader or student I think “too systemically threatening to fail” gets the idea across better than too important to fail.

  2. December 4, 2010 at 6:48 am

    Sorry I made a spelling error when quoting you above, obviously I meant to quote you “too important to fail” with 2 o’s. My spelling error not yours. The overall message is same though.

  3. Lawrence
    December 4, 2010 at 10:53 am

    Hi Ted, yes I think that is more accurate. I was just using the phrase of the day. Lawrence

  4. December 4, 2010 at 11:40 pm

    Hah!! I thought you would agree!! BUt you know the conservatives/wealthy/Republicans take hostage the terminology from us!!! It’s true!!! And that is why we must insist on our own terminology and HAMMER it home like a nail. I’m not trying to make a deal out of it, but you know that what I said is true. The terminology is often “taken” “Stolen” from us. This is the deal. “to important to fail” doesn’t do the situation right. And you have to be as angry as a taxed Republican is angry about it……. not a tenured Professor congratulating himself on his gratuity.

  5. December 4, 2010 at 11:43 pm

    Hammer it down on Boehner’s nicotined stained hand.

    This writer for Slate gets it:


    You didn’t get it yet. Get the argument straight, not just self-righteous indignity.

  6. December 8, 2010 at 7:15 pm

    Lawrence, are you with me Brother??? We’re two bitter guys trying to snatch stuff from an overpriced SuperMall. Check my blog….. come on Brother, we’re together on this. Don’t go John Ritter’s character on me…

Leave a Reply

Your email address will not be published.