The Bankers' New Clothes: What's Wrong With Banking and What to Do About It

and a tsunami occurred in 2011, this neglect led to a nuclear disaster that was entirely preventable.
    Weak regulations and ineffective enforcement were similarly instrumental in the buildup of risks in the financial system that turned the U.S. housing decline into a financial tsunami. Yet, despite the wreckage, serious attempts to reform banking regulation have foundered, scuttled by lobbying and misdirection.
    Banking is not difficult to understand. Most of the issues are quite straightforward. Simply learning the precise meanings of some of the terms that are used, such as the word capital, can help uncover some of the nonsense. You do not need any background in economics, finance, or quantitative fields to read and understand this book.
    In this book we discuss many statements and views. At times we use generic terms, attributing statements to “bankers,” “regulators,” or “politicians.” Having talked and collaborated with many people connected to banking and public policy, we know that not every banker, regulator, or politician subscribes to the same views. Many in these groups and elsewhere advocate and work to bring about beneficial reform. In each of the groups, however, the views we discuss are so prevalent, and have had such an impact on policy discussions, that we feel justified in generalizing to make our points.
    Do not believe those who tell you that things are better now than they had been prior to the financial crisis of 2007–2009 and that we have a safer system that is getting even better as reforms are put in place. Today’s banking system, even with proposed reforms, is as dangerous and fragile as the system that brought us the recent crisis.
    But this situation can change. With the right focus and a proper diagnosis of the problems, highly beneficial steps can be taken immediately.
    Having a better financial system requires effective regulation and enforcement. Most essentially, it requires the political will to put the appropriate measures in place and implement them. Our hope in writing this book is that if more people understand the issues, politicians and regulators will be more accountable to the public. Flawed and dangerous narratives—“the bankers’ new clothes”—must not win.
    October 2012

ACKNOWLEDGMENTS
    I N WRITING THIS BOOK about borrowing and its dark side, we have ourselves borrowed a lot and experienced the bright side of borrowing. We have borrowed a lot of other people’s time, attention, and thoughts, and we have experienced the pleasures of interacting with them. Some interactions occurred long ago, in discussing pure research, some more recently, in discussing policy and regulatory reform since 2007.
    Writing a book on banks and banking regulation that would be accessible to a nonprofessional reader has been a great challenge. We are very grateful to many friends and colleagues who encouraged us to take on the challenge and kept us going with support and advice along the way.
    We are particularly grateful to the following people, who read earlier drafts of at least portions of the book and made numerous useful comments: Philippe Aghion, Neil Barofsky, Jon Bendor, Sanjai Bhagat, Jules van Binsbergen, Christina Büchmann, Rebel Cole, Peter Conti-Brown, Pedro DaCosta, Jesse Eisinger, Christoph Engel, Morris Goldstein, Charles Goodhart, Andrew Green, Susan Hachgenei, Dorothee Hellwig, Hans-Jürgen Hellwig, Klaus-Peter Hellwig, Marc Jarsulic, Bob Jenkins, Simon Johnson, Birger Koblitz, Arthur Korteweg, Tamar Kreps, James Kwak, Alexander Morell, Stefan Nagel, John Parsons, Dieter Piel, Joe Rizzi, Steve Ross, Ingrid Schöll, Graham Steele, Monika Stimpson, Tim Sullivan, John Talbott, Matthias Thiemann, Rob Urstein, Jonathan Weil, and Art Wilmarth. The reviewers of the book for Princeton University Press (PUP) also made very helpful comments. Special thanks to Paul Pfleiderer, who was involved in many brainstorming sessions and made numerous useful suggestions about different drafts.
    We also thank members of the financial stability group convened by Anat Admati and Simon Johnson at the Peterson Institute for International Economics in Washington, D.C. Generous funding by the Institute for New Economic Thinking supports this group, including a meeting in June 2012 to discuss this book.
    While engaging in the policy debate in the past few years, we have had many helpful discussions with colleagues and with individuals involved in the policy debate and others, which