The Banker's New Clothes Case Study

The book The Banker’s New Clothes: What’s Wrong with Banking and What to Do About It was wriiten out of necessity after the worst economic downturn in the United States in more than eighty years. The massive breakdown of the United States housing market in 2006 and 2007 had overwhelming consequences on domestic and global economies and devastated the global banking systems. Between 2001 and 2006, many large financial institutions had accumulated large positions in the subprime mortgage market that gave out superb returns. Asset prices in this market inflated to unreasonable levels due to the quality of the loans being packaged and sold by commercial bankers and would soon create a major asset bubble in the markets. The bursting of the housing

Many economist argue that placing stricter equity requirements on banks would increase the cost of lending, thus slowing down economic investment and hampering the economy’s growth. This is the reasoning behind the steady decline of capital that banks are required to hold. By decreasing reserve requirements, more loans can be made hence more economic activity, which hopefully results in economic growth. One problem with this counterargument is that once growth starts to slow down and markets begin to regress, the banker’s equity gets wiped out of their investments much sooner if they only commit 3% of equity compared to the 25% that they were once responsible for up

But most people within the economy do not know enough about the complexities of the banking system to voice their opinion in opposition to the bankers, politicians, and regulators. This is a central concern of Admati and Hellwig and one of their main motivating factors for writing The Banker’s New Clothes. Admati and Hellwig aimed to “demystify” the banking system in order to raise awareness to weaknesses in banking policies in hopes of triggering necessary reforms to banking principles that only benefit the bankers and politicians. They state, “Expanding the policy discussion beyond the circle of bankers and banking specialists is very important, because more action is urgently needed and yet has not been taken. The banking system is still much too fragile and dangerous. This system works for many bankers, but exposes most of us to unnecessary and costly risk, and it distorts the economy in significant ways (pg. 4).” Admati and Hellwig look to level the playing field for the general public by explaining the banking system and it’s flaws in clear terms that most people can understand. By doing this Admati and Hellwig hope to reduce the recurrent economic booms and busts that have such harsh consequences for people in compromised economic situations; which are