[Here is the somewhat more coherent post I wrote before the talk]
- 14% banks
- 5% other companies
- 16% households
- 18% other financial corporations
- 8% Bonds
- 6% other securities
- 2% subordinated
- 26% derivatives
- 5% equity (of which 4% core tier 1 equity)
- 57% investment advisors
- 2% mutual funds
- 1% other
- 3% pensions
- 11% unclassified
- 4% banks
- 1% corporations
- 18% government
- 0% hedge fund managers
- 0% holding companies
- 1% individuals
- 2% insurance companies
Thought experiment: assume all bank equity and non-deposit debts of banks is owned by a single financial intermediary – an asset manager, a bit like a pension fund, unit trust, insurance company rolled into one.
Claim: asset manager owns all equity but is liable for all its debts [huh?]
Like MM reasoning
Claim: asset manager owns equity and some bank debt in bond form. A switch in funding makes no difference to this manager.
Accepts that there are some problems in this: some investors only invest in equity or in debts, may not want to switch.
There is an argument (Diamond and Rajan) about why banks may need to finance a lot of their operations in demandable debt: it’s hard for people who provide debt to be sure about what the banks are doing with their money. Maybe the managers are taking high risks. One of the advantages of demandable debt is that if it looks like management are taking advantage of their control of the assets, individuals with retail deposits can respond by getting their money back. This will cause a bank run. The fear of this disciplines the management of the bank.
But most bank debt is owned by asset managers and is not demandable in this way. So this argument doesn’t really hold.
Question is: would a change to more equity funding hurt the economy significantly? Conclusion from above arguments is – not really, as long as it’s done in a gradual way. Having banks hold substantially more capital is therefore likely to make the system safer.
Notes on audience questions from twitter feed (these are in reverse order):