Transcript: Anat Admati
The transcript from this week’s, MiB: Anat Admati on Regulations and Techlash, is below.
You can stream and download our full conversation, including the podcast extras on iTunes, Spotify, Stitcher, Google, Bloomberg, and Acast. All of our earlier podcasts on your favorite pod hosts can be found here.
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VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have yet another extra special guest, Professor Anat Admati, teaches at the Stanford Graduate School of Business. She is an expert in so many fascinating areas that you wouldn’t think are related but they really are. Why has technology developed the way it has and, more or less, exempt from a lot of government regulations or protected by government regulations?
It turns out their business model is a little similar to the way the banking industry has managed to capture a lot of regulators and continue to operate fairly freely without this sort of regulation and capital requirements and equity requirements that would make banking safer. Really a fascinating conversation about everything from misinformation to technology, to banking and financial fragility, I found the discussion to be quite fascinating and I think you will also.
With no further ado, my interview with Professor Anat Admati of the Stanford Graduate School of Business.
So, let’s talk a little bit about your background. You have a lot of degrees. You have a bachelors from Hebrew University then a Masters in Arts, a Masters in Philosophy and a PhD from Yale University. Tell us a little bit about your academic journey.
ANAT ADMATI, PROFESSOR OF FIANCE AND ECONOMICS, STANFORD GRADUATE SCHOOL OF BUSINESS: So, my journey starts where I took a lot of math. I was good in math and I love the math. It was very pretty. It was all — but I decided I probably won’t be good enough to be a mathematician. So, I was kind of, in my romantic mind when I was in my early 20s, I was going to take but not give back to math, that kind of thing.
RITHOLTZ: Right.
ADMATI: And so, I had to find something and at first, it was going to be sort of applied math like Operations Research, which was the worst kind of math, like optimization.
RITHOLTZ: Yes.
ADMATI: It’s kind of boring and — but I got an opportunity to go to Yale and these degrees were just kind of simultaneously gotten. I mean, I was at Yale in three and a half years with all those degrees.
RITHOLTZ: OK.
ADMATI: And I just — an opportunity landed on my lap to go to this program in Operations Research at Yale and I was promised that Yale is very interdisciplinary and once you passed your qualifying exams, you can do whatever you want.
RITHOLTZ: But?
ADMATI: And I had never taken an economics course before that. But when I got to Yale, my advisor said, why don’t u take microeconomics and take mathematical economics and take some economics. And by the end of the first year, I kind of knew a new language like I — and it was all much more interesting because there was interactions with people and equilibrium and all of that.
And by second year, I took the course that was absolutely a must-take in the crowd that I was hanging with, which was Steve Ross’ Financial Economics. Yale didn’t even have a programming in finance. The School of Management was just created. This was back in the late ’70s, early ’80s and he was just teaching people all they needed to know about finance, which was just coming up.
RITHOLTZ: They had become professionalized when before it was just a bunch of …
ADMATI: Exactly.
RITHOLTZ: … disparate theories. So, you find your calling in economics. But you really take some of your background and dig pretty deep into financial regulations in technology. Where did the tech background come from?
ADMATI: And then — I’ll tell you. So, that all — I was totally in the sort of finance bubble, first kind of market microstructure, trading mechanism. This is the quaint 1987, a little Black Monday, small Black Monday.
RITHOLTZ: Just that little one day glitch. Sure.
ADMATI: The little — 19 percent decline in one day.
RITHOLTZ: Twenty-two, twenty-two point something. Yes.
ADMATI: Yes. So, it was program training and insurance …
RITHOLTZ: Yes.
ADMATI: Portfolio insurance and all these application strategies and all this stuff. And so, that was kind of the little crisis of the day, right, in the little detail and this before high frequency trading and all the rest of it.
RITHOLTZ: Right.
ADMATI: But then I worked on trading mechanisms and information getting to prices and informed and uninformed trading and markets for information and newsletters and managed money portfolio theory. And then I got more interested in kind of governance but governance in the narrow sense, corporate governance and contract, which was all about the problems between shareholders and managers.
So, that was that and then comes the financial crisis. So, until the financial crisis of 2007 and 2009 or however you go — you actually time it, I was in this finance bubble. I was teaching corporate finance. I did research, theoretical research. I built on mathematical models and analyzed them. And I lived in that little bubble thinking all is well until this crisis, I was like, what just happened?
And so, I never was interested in banking particularly we have a lot of silos even within economics …
RITHOLTZ: Sure.
ADMATI: … let alone in all the social sciences and law and all of that. So, we’re itching our little silo with our little journals, all this stuff. So, I just go curious, wait a minute, I teach corporate finance, the bank is also a corporation, now why does it have like almost no equity funding, what’s going to there?
I teach people capital structure theory and what — how are bank so different, why are they so different? They hate equity with this fashion. And so, the more I dug, the weirder it got. It really like I fell in a rabbit hole. It totally was rabbit hole, like curious or uncurious or that kind of thing.
RITHOLTZ: Well, tell me if I’m oversimplifying banking because what we’ve seen over the past half century before the financial crisis was simply banks figured out that the less capital they keep on the books, the better their profit margins appear even though they’re essentially just assuming more risk and the better their profit margins are, the richer everybody got.
And so, we’ve seen a half century of first deregulation then fairly radical deregulation, all of which works to the banks’ advantages until suddenly it no longer did.
ADMATI: So, in the book, we go through a lot of the history of banking, including the basic banking model, which is sort of it’s a wonderful life kind of 363 boring banking model and that too had a crisis in savings and loan and in many other banking crisis.
RITHOLTZ: Right.
ADMATI: So, it’s not like — banking is inherently risky because inherently, the banks taking risk with depositors’ money and the depositors are unable to really behave like normal creditor. And that’s really sort of the beginning of the sort of original sin in banking that they’re always overleveraged. Always. They’re never efficient in providing any of the services on both sides of the balance sheet because they always have the temptation and the ability to take just a little bit more risk on both sides of the balance sheet.
RITHOLTZ: That’s the nature of fractional reserve lending, you get …
ADMATI: Well, but it’s their incentives. So, the key to understand it it’s not like essential or efficient. It’s just that that’s how they want it. So, the thing is that banking is sort of inherently fragile because banking is inherently inefficient that way or forever poorly regulated or poorly controlled by their investors, including the depositors.
So, to that, you add expansion in the business model that allows taking more risk, hiding more risk with derivatives, with universal banking, all of that, and the increase in safety net, implicit and explicit, with deposit insurance, with all of that. They became able and obviously interested in living more and more and more in debt.
Now, even my research, even after the first — after the book, we were already beginning to do this research, I understood a lot better. Stuff that we teach in basic courses is very static theory of how companies fund and it’s like one round of funding, debt and equity, and then the world is over.
But for well-living breathing companies, any company, their funding decision as well as investment decisions are always made by shareholders or managers on behalf of shareholders maybe in light of previous commitment. So, in the dynamics of it, once you took debt, your preference has changed completely. You’re no longer maximizing total value of the firm. You’re maximizing the value of equity in the firm.
And from that perspective, equity seems expensive to all heavily indebted corporations, banks in particular, because for other corporations, if they take on more and more debt, the creditors will start pushing back. The creditors will start putting covenants. The creditors will jack up their rates because the creditors will worry about all the distorted incentives of the borrower or lender.
That happen. Gambled the money in Las Vegas or under investing things because there’s not enough upside. All of those things that characterize sort of the fortunes that characterize heavy indebtedness.
RITHOLTZ: So, that makes the finance sector very different than the rest of the stock market?
ADMATI: Well, the banking especially because the creditors in banking are particularly passive. And so, therefore, the usual market forces that push against high leverage in other companies that just naturally with no regulation would limit. There’s no corporation that lives its healthy — unless they’re on their way to bankruptcy that lives with single digit equity numbers. Of course, it depends how you measure it and there’s book market, all kinds of other things that we can discuss.
But the banks basically got used to — and got stuck and it’s very addictive to be there especially at this extremely low equity level. From that vantage with the overhang of debt being so, so heavy that you’re effectively insolvent all the time but you just not recognize as such. Then you hate equity …
RITHOLTZ: Hold on a second.
ADMATI: … you want to take money out.
RITHOLTZ: So, let’s stay with that point…
ADMATI: Yes.
RITHOLTZ: … because that’s pretty fascinating. It was pretty clear to observers that the reason Lehman brothers didn’t get bailed out is they were not just a little insolvent but deeply insolvent.
The rest of the banks that were out there that survived seem to recapitalize. They sold equity. They brought more money in. Goldman Sachs took a big chunk of money from Warren Buffett. JPMorgan Chase bought Washington Mutual. They did more capital reserves and they ended up buying Bear Stearns as well.
ADMATI: When you say capital reserve, again, I mean, people get very confused about what that is. You mean …
RITHOLTZ: They put more cash …
ADMATI: No. No. No cash. Not cash. Capital is not …
RITHOLTZ: Just straight-up equity.
ADMATI: Capital is not cash. It’s on the other side of the balance sheet. Capital is about how you fund. It’s not cash reserve. OK. So, it’s — this is really important, there’s a pile of cash.
RITHOLTZ: So, let’s put shelves (ph) into that.
ADMATI: It’s — let’s dive into that because it’s very, very confusing. To this day, you can find people saying set aside cash. That’s not what capital is about. Capital is about — obviously, there is the measurement to get at a given point of time but when you take a snap shot and you say — talk about capital ratios or risk-weighted capital ratios or all of that, they’re entirely on the funding side.
So, you got your assets whatever they are. They have some risk and whatever — however you put numbers on that sort of accounting or — and what’s allowed and not allowed and all of that is like a big can of worms actually. But –and netting of derivatives and all of that.
But then the question is how do you fund those assets. And so, the question is how much gets funded by making promises to investors by debt. Any kind, collateral, non-collateral. Now, deposit is very unique because deposits are unsecured debt to the bank. But …
RITHOLTZ: To the depositors.
ADMATI: To the depositors. They don’t have collateral.
RITHOLTZ: Right.
ADMATI: OK. So, it’s the FDIC that’s holding the bag there. Now does the FDIC even know how much risk they’re bearing 0 when all the assets are so encumbered that they’re all pledged as collateral?
RITHOLTZ: Do they? Because one would assume …
ADMATI: No, they don’t.
RITHOLTZ: … they — now, I have a very vivid recollection during the financial crisis of the FDIC talking about their reserves dropping from 90 to 60, I think it dropped as low as $40 billion
ADMATI: Yes.
RITHOLTZ: And hey, if we get a bunch more disasters, we’re not going to be able to cover the depositors.
ADMATI: Exactly. Because they stopped charging. Also because there were no defaults before the crisis. They stopped charging deposit insurance and all of a sudden, there was a lot of bank failures, not the big ones except for Lehman but Lehman wasn’t an FDIC insured bank.
RITHOLTZ: Right. Right.
ADMATI: And so — but when the other banks, small banks, started failing, what do they — what can the FDIC do in general? Well, they can go back to the large banks and just assess them more because they have no way and I can assert this you, no good way to risk adjust their deposit insurance fees. They’re supposed to be self-financing the FDIC through fees but they really are taking a huge leap for insuring what by now must be like, I don’t know, $13 trillion and more will come if there were tremors because money moves back in deposit from money market funds and all of that.
RITHOLTZ: From uninsured money market to ensured bank deposits.
ADMATI: Exactly. And so, the FDIC, which is assist for corporation, is totally backed by the government. However, in practice, they can — they have a line to treasury for, I think, 500 billion or something.
But if — should something actually happen? So, we’re all on trust with the system. They tell us don’t run, don’t rush, your money is safe. And I trust that,
RITHOLTZ: No bank runs.
ADMATI: No bank runs.
RITHOLTZ: So, when you …
ADMATI: So, we saw the problem …
RITHOLTZ: When you say that they stopped charging fees, I’ve been under the impression that the banks that have that nice little logo, the emblem, FDIC insured, aren’t those banks paying some small percentage of …
ADMATI: Usually, they do and basically, I once asked a 40-year veteran of banking in all the biggest banks through the ’60s, ’70s, ’80s, ’90s who was basically came out of retirement to being a private equity firm that was buying distressed banks from the FDIC and he said to me, you’re looking at the big banks, let me tell you what goes on in the small banks. And then I asked him the following simple question because there are thousands of small banks in his country.
RITHOLTZ: Right
ADMATI: I said, what’s the business model of a small bank? And the answer …
RITHOLTZ: They get purchased.
ADMATI: The answer was three words, the business model, in other words, the positive net present value of the bank, he said, subsidized deposit insurance.
RITHOLTZ: Subsidized deposit insurance.
ADMATI: That’s it. In other words, their entire finding — so what they do on the asset side, anybody can do, zero NPV, commercial real estate, whatever.
RITHOLTZ: Right.
ADMATI: And how they fund is where they’re privileged. Now, what happens, my model of banking safety — basic safety net is that big banks may well be overpaying for the deposit insurance part to the FDIC and the FDIC — and they pass on some subsidies down to the small bank. So, they keep happy enough.
And because the big banks have implicit guarantees that are priceless because they have access to the Fed and that is worth a ton. In the financial crisis, let’s remember, Goldman Sachs and Morgan Stanley became bank holding companies
RITHOLTZ: Right. Previously, they were brokerage firms.
ADMATI: They were investment banks.
RITHOLTZ: Right.
ADMATI: Regulated by the SEC which also Lehman was and at that time, the commercial banks, so Citibank within Citigroup, were regulated among others by the FDIC and the FDIC had Sheila Bair and Sheila Bair refused to implement this Basel II that had fancy-schmancy risk weights. Manipulable ways, model-based ways to allow the banks to tell us how risky they are and therefore, determined their equity requirements.
RITHOLTZ: In other words, mislead regulators …
ADMATI: And there’s research that showed that banks in Germany that were allowed to use this advanced approach to this fancy scientific approach to regulation were misrepresenting their own risk and making more loans with less risk weights. In other words, inappropriately low risk weights.
RITHOLTZ: Just for that one small leverage.
ADMATI: And the — yes. And, of course, the epitome of the failure of this regulation is assets that had zero risk weight but were risky like AAA rated security like Greek government, lending to Greek government in Europe. I mean, the banks in Europe basically fed this subprime lending to the Greek government.
RITHOLTZ: Havong stories and he is in
RITHOLTZ: Why should Greece pay more in interest rates than another country like Germany? That doesn’t make any …
ADMATI: Well, they paid a tiny sliver but the French banks just went and lent them a ton and when they couldn’t pay, the European Union and all these other countries and the regulators that — who allowed these banks to make this reckless loan who had just bailed out these banks from investing in our real estate bubble …
RITHOLTZ: Right.
ADMATI: … couldn’t admit to their citizens that they would bail out their banks again if Greece default. So, that — they blamed all the things on the lazy Greeks and they kept bailing out Greece so Greece could pay the banks until the banks got out.
So, that was the zero risk weight for sovereign lending in Europe and it’s just one example of how awful, awful the regulation was pre-crisis. And then you tell me that they recapitalized and did all of that. I’m not so impressed. Yes.
First of all, Bank of America and Citi were zombies coming out of the crisis.
RITHOLTZ: Right.
ADMATI: Despite multiple bailout of Citi.
RITHOLTZ: Citi for sure. Bank of America, not much better.
ADMATI: Both of it. (inaudible) and zombie banks, I mean, I believe that. They were the examples where if you wanted to have this systemic resolution through the FDIC, we could have tried it in a — not in a crisis.
RITHOLTZ: Meaning put them into a pre-packaged bankruptcy.
ADMATI: Yes. Show me that it works. Show me that it works. Outside the crisis where everybody’s failing. I was in this FDIC Systemic Resolution Advisory Committee, was part of Dodd-Frank, was saying, if Lehman Brothers was sent to the FDIC for resolution because FDIC knows so well how to do the small bank resolution just come over the weekend, take over small bank and the people don’t even know.
RITHOLTZ: Because they’re the same. Because Lehman Brothers are — so, Lehman Brothers had repo 105 where they were moving all of this risk in order …
ADMATI: Thousands of subsidiaries.
RITHOLTZ: Right. Just hundreds of billions of dollars and misrepresenting their books …
ADMATI: Do you know …
RITHOLTZ: … to their – to the regulators and to the investments.
ADMATI: Do you know that the Lehman bankruptcy is not even over yet? Every year, I go back and check.
RITHOLTZ: Yes. Still going on. Right.0
ADMATI: Still going on.
RITHOLTZ: Still on though.
ADMATI: So, this is how unresolvable this. Now, in the first …
RITHOLTZ: To be fair, it was only 15 years ago.
ADMATI: And it was a small — it was a small one by — I mean, this was the biggest bankruptcy at that time but there were …
RITHOLTZ: Right.
ADMATI: There were fraction of JPMorgan Chase or Citi or all of these that they tell you now can fail without and they have them do living with this all kind of stupid things.
RITHOLTZ: I don’t think JPMorgan Chase had failed.
ADMATI: No way. No. Because we don’t even …
RITHOLTZ: If they did, it would just be incredibly disruptive.
ADMATI: Exactly. So, I’m not even blaming for bailing out. I am blaming for not doing basic prevention
RITHOLTZ: So, that raises really interesting point. You mentioned the French banks and the lazy Greeks When you offer people free money or dramatically discounted money, we shouldn’t blame the Greeks who took, hey, this is a great deal, we’re going to take this. You have to look at the banks that lent it to them and said, why these banks being so irresponsible and reckless to make such cheap loans to …
ADMATI: Under the eyes of their regulators.
RITHOLTZ: Yes.
ADMATI: Under the eyes of their regulators. So, the regulators are not being called to why they allowed these loans to be made by too-big-to-fail French and German banks.
RITHOLTZ: Right.
ADMATI: French banks had in 2010 40 percent of Greek bond, government bonds.
RITHOLTZ: That’s amazing.
ADMATI: Yes. And Greece only did a little bit of restructuring after the banks pretty much got out, left the troika creditors to be a bailout fund of European nations. ECB and IMF, those where the troika.
Now, why did IMF invest all? Because IMF was led by some French. No. Because IMF should not have intervened in a European …
RITHOLTZ: It’s not their chore.
ADMATI: Into European thing. Europe had enough to be able to resolve this. They just didn’t want to. So, IMF, being led by French people, Dominique Strauss-Kahn and then later by Lagarde who had to deal with it later in 2015 when they were kind of adopting their room if you want to call it.
RITHOLTZ: So, let’s throw a parallel. The French banks and the Greek borrowers, there were a lot of people criticizing in the 2000s the U.S. homeowners who were taking HELOCs and refinancing and taking loans and I look at it as it’s not the responsibility of the consumer when an institution like a large bank says we’re going to loan you money and we’re not going to charge you interest for three years and then we’ll reset but don’t worry about it.
The individual consumer doesn’t understand that. Wait, free cash, where do I sign? It’s the banks and the regulation, the regulatory …
ADMATI: It’s the lady in the hot tub in “The Big Short” saying she’s got five houses.
RITHOLTZ: Right. That’s right.
ADMATI: Exactly. So, the question is how …
RITHOLTZ: There is parallel decrease.
ADMATI: No. Exactly. So, that’s why I used subprime to kind of raise a parallel. Yes. So, reckless loans were made to people who couldn’t pay, liar’s loans who are clearly couldn’t pay because of the commissions of the mortgages …
RITHOLTZ: The whole structure was stuck.
ADMATI: The whole structure. And you still had the Fed assuring us everything was fine there and you had a system incredibly levered and interconnected, create through all these contagion mechanisms that we explained in the book. A perfect storm from a small decline in housing prices. I mean, this should — the correction, the price collection itself was much smaller than …
RITHOLTZ: Thirty percent of elevated …
ADMATI: Than like Internet bubble burst.
RITHOLTZ: Right.
ADMATI: Which wiped out a lot of paper wealth.
RITHOLTZ: And to put some numbers on that, the Internet peak to trough was about 81 percent decline in the NASDAQ comp whereas I think houses fell about 32 percent. Some sector — some areas that …
ADMATI: And then there was some default. OK. But it means the amounts were trivial really. And how do they create a global financial crisis from a little housing bubble burst in the U.S.?
RITHOLTZ: Securitization and it spread through everywhere.
ADMATI: And super-duper triple securitization that are side bets basically on the mortgages and only the big short, they made money.
RITHOLTZ: I mean, quite amazing. One of your research pieces really caught my eye. I love this title, “Is The Internet Broken?” Tell us about it.
ADMATI: That was actually the title of a course that I taught with one of the producers of HBO “Silicon Valley” where …
RITHOLTZ: Which we’ll talk more about later.
ADMATI: Which — yes, which I got to be involved in in the last season only and therefore, it was — it was one of the ones I streamed kind of had to been stream sort of to see also the season I ended up at also being a cameo in the last, last show with Middleditch, the whole thing and being there in the Stanford graduation and decorating his office and all that stuff.
Anyway, banking is super regulated but poorly regulated but it’s like born — kind of born tied at the hip with the state, with the government because of central banks, because of — so they’re just — because they’re about money, they’re kind of intertwined with government in ways that not everybody understands because they’re still private corporations but they are super-duper connected.
RITHOLTZ: And just to put a little context about that, in the first, I don’t know, century of American history, they were completely independent and they failed with shocking irregularities (ph).
ADMATI: Because they were all — because we had regulations that also prevented them from diversifying. So, they were very subject to local calamities and they just kept failing and their privately issued money was good as long as it was good and it wasn’t.
So, then we decided to have a currency and the whole history of banking et cetera until we got to have national banks and these mammoth banks that consolidated and consolidated and still thousands of other banks. So, just a bloated huge system anyway.
So, I was basically — I’ve seen banking since I started looking at it in 2009, 2010 and then becoming involved in that, consumed with that lobbying for policy, how I get to …
RITHOLTZ: So, how did you go from banking to technology and the Internet?
ADMATI: So, here’s what happened. So, then it’s over 2015, I’m kind of have already spent like literally five years of my life, fulltime, on banking where I just came to look and here I was just — and it’s just kind of — it’s a little bit sickening to kind of being in that environment. I’m like, wait a minute, I’m in Silicon Valley and now, at that point, there was already the first round of what’s called techlash. That was Cambridge Analytica.
RITHOLTZ: Techlash. Right.
ADMATI: That was when all these tech companies stopped being the ones we love the most and we started being a little bit suspicious. You started having the people saying, it’s addictive and — that was first time, not Francis Hogan, which is more the more recent after the 2020 election or whatever. But this was kind of after 2016 and into ’17.
So, I became curious about this sector as a factor just to — because I come from my — my original interest was in corporate governance generally. Corporations run on behalf of shareholders and what’s the implication, which in banking I saw were disastrous because they could get away with all the stuff they got away with which was extremely inefficient and included all kinds of bad policies, tax subsidies of debt, all kinds of things that I saw no reason for to somehow stop bad bankruptcy coded.
RITHOLTZ: Is technology any better?
ADMATI: Well, so, I wanted to check. So, I’m like, here is a factor that has sort of an origin that’s completely different. In other words, born free. Born free in the sense that they got started in the private sector. A lot of the — even the innovations, the things that are wonderful that we take for granted, the fact that our email goes for free that all of a sudden we have all these communication technologies. And let’s remember though that the Internet itself started with the government, started with (inaudible) and all of that.
RITHOLTZ: Same with semiconductors began with NASA.
ADMATI: Right. Exactly. So, let’s remember that the government got it sort of started and then obviously, there were a lot of innovations. There was a mouse and there was the, of course, the browser, the first search engines, all of that in the ’90s.
So, it’s a very young sector, the Internet, and now, we’re all digital now all the way to mobiles. So, first, it’s desktops and Internet when I sort of — in the ’80s, we were writing emails in the ’80s already but it was — then there was laptop and then there was mobile.
And so, this whole move to where we got our digital everywhere and we’re so connected in the World Wide Web, which was pretty recent innovation, sort of 2000 or early 2000s. It was fascinating to me in terms of how it interacts or not with government because people were beginning to think something’s wrong with it, privacy issues, net neutrality. I mean, the world is tough, I had no clue what the policy was.
I ended up taking a dip into banking regulation and now, what — is there any — what is the regulation, how is it different from telephone, how is it different from newspaper, how is it different from TV, what sector does it disrupt. OK.
RITHOLTZ: So, let me jump in and ask you a question about that. Section 230 is a big regulation that tech companies get to use to say, we’re not a media company and we’re not responsible for misinformation. We’re a platform.
ADMATI: Yes.
RITHOLTZ: Tell us about Section 230 and what we should know.
ADMATI: Yes. So, I didn’t know about Section 230 until I started delving into the Section 230, what is it? There’s a whole book about the 19 words that changed the Internet.
RITHOLTZ: And they are?
ADMATI: And they are the government cannot regulate — cannot tell these companies — they’re immune from any litigation on content. Now, proceeding this, there were a lot of lawsuits that were targeted at companies that actually tried to moderate content like Compustat. It’s a — so, you had these servers, these platforms, and the ones that claimed to do some moderation like to keep it family friendly or this or that were getting sued for content that was left up. Some enemy of mine posted something that I was related to Columbine or some nude pictures of me or whatever.
And they constantly had to deal with being sued. And so, they wanted — but the government — so, there was this sort of a bargain made with them that we will give you immunity from lawsuits and the idea was that it would enable you to moderate.
RITHOLTZ: In other words, you’re a platform not a creator of original media context.
ADMATI: Right. Because you — people just post. OK. So, you’re not responsible for that content but, of course, then comes a slippery slope which is newsfeed, which is the data gathering that happens that Facebook, for example, collects.
RITHOLTZ: And then ultimately, misinformation and disinformation.
ADMATI: Exactly.
RITHOLTZ: Are these companies being responsible members of society? Are they hiding behind 230? How do you take that apart?
ADMATI: Well, they — they’re obviously for-profit. I mean, when Google started, I — in that class, we dug into it. When Google started, the creators of Google were at Stanford and they said at that time they didn’t like advertisements. They thought search should be run as a nonprofit in the academic domain.
And they — Google started with Stanford — Google search and then a web -search -.- So, it started right at Stanford just like Facebook was for college students to meet people-.
RITHOLTZ: Righ–t.
ADMATI: And so, then Internet bubble burst and they wanted to get funding and go public and all kinds of things like that and then investors …
RITHOLTZ: Same as Yahoo tried to buy them from a million dollars and they said, let us think about it and it didn’t — the deal never went down and it turned out to be quite financially remunerative to them.
ADMATI: To the Google. Yes.
RITHOLTZ: Yes.
ADMATI: And so, then they had their venture capitalist and they have their people breathing down their necks to produce and all of a sudden, all their nice words about how they are against advertisers then they were sort of — they …
RITHOLTZ: That was then.
ADMATI: That was then. And then they found more and more and more ways to monetize the predictiveness of where people are going and sell that to advertisers and targeted ad and all of that. By then, also destroying newspapers, especially local newspapers, and therefore, becoming — and then, of course, the way they curate.
So, now, you’re going to say I didn’t create this content, it’s not my content, I will have some filters to remove naked people or whatever else and — but now, I’m going to curate a newsfeed to you that I think is what you want to see. Now, maybe what you want to see is the things that you’re going to get aroused by that create engagement, which became sort of the mantra for what they were looking for is to get you to spend more time and therefore, give them more information.
So, you kind of trace the business models and you step back and ask, well, how is that working out for us, and the surveillance capitalism, what Zuboff calls, et cetera, was beginning to not work very well already in 2017, 2018. And the “Silicon Valley” HBO series in the last season was sort of seeing that trend and they wanted to kind of capture the fact that all of a sudden, Zuckerberg is in front of congressional committees and the sort of beginning rumbling about what’s going on there.
RITHOLTZ: So, let’s break this down to a couple of different topics because there’s a lot of things going on especially when we’re talking about Google and Facebook. So, hold aside local newspapers and others that were hurt by Google, Facebook, Craigslist, eBay, going down all the list of things that they used to generate revenue from and a lot — Zillow is another one.
Think of all the ad revenue streams for it. Now, it’s pretty much subscription and a little bit of advertising.
ADMATI: Yes.
RITHOLTZ: But let’s talk about some of the big things you brought up. One is misinformation. The other is the engagement that the algorithms are driving outrage, not information. What are the responsibilities of these companies and what are the responsibilities of regulators to look over these companies and say, are they doing a good job or are they causing societal damage?
ADMATI: So, I delved deeply into it and I’ll give you just a brief answer. First of all, there’s some debate about why our ecosystem of sort of just engagement with each other has gotten so toxic. And you can — it doesn’t — it’s not all from the Internet.
I mean, you can talk about cable television and Rush Limbaugh and Fox News or whatever or whoever is your channel that you think is …
RITHOLTZ: America’s News Network, Newsmax.
ADMATI: So, some of it is TV.
RITHOLTZ: The extremists have really gotten extreme.
ADMATI: Right. So, exactly. So, we had this on polarization with all the proliferation of media outlets and people choosing their silo. So, it’s no longer the evening news …
RITHOLTZ: Right.
ADMATI: … that gives you the truth anymore. Everybody has their own truth. And the Internet is just one place where that happens. Now, the problem with the Internet and I think what needs to happen, so, first of all, this country has a First Amendment, which means that the government can’t do much.
RITHOLTZ: Can’t stop you from criticizing the government or engaging in political speech. There are areas that can be restricted.
ADMATI: But very little.
RITHOLTZ: Well, yes, very little.
ADMATI: We’re at the mercy of these private companies.
RITHOLTZ: Right.
ADMATI: Now, what we can do and what we can regulate is just, first of all, what happens behind — what is actually going, what people seeing. Let’s see — let’s — U.S. researchers unable to access the data to even know how much misinformation what are people reading. I mean, even in the …
RITHOLTZ: Because they’re private companies.
ADMATI: Yes. Because they don’t release it because they do not — they’re not forced to disclose relevant information to the public, to researchers. Anonymize them all but just so we can understand what their impact is on our lives.
RITHOLTZ: And that seems like a pretty fair trade for the government to say, we’re going to continue giving you Section 238 — 230 protections but in order to qualify, you have to release all this data.
ADMATI: A lot of data is the absolute starting point of that.
RITHOLTZ: That seems like a fair amendment to keeping all these …
ADMATI: Yes. So, there are few …
(CROSSTALK)
RITHOLTZ: … back.
ADMATI: There are people more involved. In that policy debate, I basically became conversant enough at least to teach a course. I haven’t done a lot of writing on it. I basically took it into my examples of two sectors, banking and Internet, that sort of seem to have some kind of a clash with democracy basically.
RITHOLTZ: Because of the need for government exemptions and regulation and support in some way versus just the wild west unfettered.
ADMATI: Because — the government is always there’s. It’s what it does and what it doesn’t do for all sectors. It’s the rules of the game for the economy and they affect all companies. That’s labor law, environmental laws, all kinds of consumer protection laws and some specific regulations, airline regulation.
And there’s rules, the speed limits, the rules of the road for companies and for people, OK? Are you allowed to do mandatory arbitration or not? There’s just thousands of things that — where the law in general, not specialized to a sector but just the laws that exist, anti-discrimination or you name it.
I mean, Facebook got in trouble for allowing people to mock race as a thing and put housing ads in front of people from a certain race. That was against …
RITHOLTZ: Because it’s supposed to be race blind …
ADMATI: Yes. So, they got against basic civil rights law that – so they have to interact with all laws. They have to obey all laws, minimum wage, all kinds of laws.
RITHOLTZ: Right.
ADMATI: And so, now, that’s my current interest, which is the corporation, as a legal person, they are not a set of assets owned by shareholders. They are a separate thing, right? Twitter is a thing. They have a board. They have shareholders. They have various stakeholders. Everybody has some claim or some control in some cases.
How do they — how does the corporation, as a legal person, interact with the rule of law in general? They have rights. They have responsibilities. Who’s home to get more and more rights? They send lawyers to get more and more rights in the courts, political speech rights, religious rights. They get more and more rights in the courts.
And responsibilities, there’s kind of nobody home when you come for — you caused harm, when you come for say Boeing or Purdue or PG&E, all these companies. That’s what I’m interested in now.
A corporation living in a legal environment, who are they, what if they harm, what happens, what can we do?
RITHOLTZ: Well, you named some companies that have run afoul of the government because they engaged in some pretty bad and sometimes reckless or even illegal activity. So,you mentioned Boeing. They didn’t do a great job with their 7 …
ADMATI: 37 MAX.
RITHOLTZ: Right. That was problematic.
ADMATI: Yes.
ADMATI: They took a bunch of shortcuts. Arguably, they did not follow their own internal procedures.
ADMATI: Well, they were competing with Airbus.
RITHOLTZ: Right. You mentioned Purdue, engaged in all sorts of behavior where it was pretty clear, hey, we can ship this much …
ADMATI: No. They ship — there was all the enablers around them, the McKesson and all the pharmacies and all of that. Purdue and other …
RITHOLTZ: But they know internally.
ADMATI: They …
RITHOLTZ: This is a town of 300 people. Why are they getting 8,000 …
ADMATI: Right. There was distribution — they were marketing it through the doctors and to the public using false claims and misleading …
RITHOLTZ: Deceptive. Deceptive.
ADMATI: Deceptive marketing.
RITHOLTZ: Right. Right.
ADMATI: Now, what happened? No individual in Purdue was — three were criminally charged.
RITHOLTZ: Their names will come up for a couple of library cells. So, you got that. That’s a problem.
ADMATI: Yes. But — yes. But the Sacklers took away a whole bunch of money to private company.
RITHOLTZ: Billions. Billions.
ADMATI: And then they sought release from the bankruptcy of Purdue, not themselves.
RITHOLTZ: Right.
ADMATI: Release from all civil liabilities which a court — above bankruptcy court struck down and now we’re — we were nowhere, it’s a mess. That company cannot possibly make up for the harm they caused.
RITHOLTZ: Right.
ADMATI: And, voila, the Sacklers name is obviously not as prestigious as it used to be.
RITHOLTZ: There should be some claw back of the billions of dollars that were extracted from the company.
ADMATI: This is like fraudulent conveyance.
RITHOLTZ: Yes. Absolutely.
ADMATI: I mean, in bankruptcy usually, you say you took money out, you diverted money knowing that this thing is going to collapse.
RITHOLTZ: And you’re in bankruptcy. Right.
ADMATI: Yes. So, ahead of bankruptcy, they can look back …
RITHOLTZ: You were supposed to be acting on behalf of the creditors.
ADMATI: Well, but they were the owners. I mean — so exactly. So, the creditors can — now, the creditors of Purdue are mostly victims and insurance companies and the government. So, in the bankruptcy court, all these stored victims including people whose family members died, people who are addicted, Medicare, all the insurance companies that had to pay all the municipalities, all the states, I mean, you got claimants from here and Department of Justice comes and says, well, you — you call a Medicare fraud, we want billions of dollars, who gets the little pie the remains?
RITHOLTZ: Well, that’s for the judge to assess. But you can assess those damages without having access to the capital or the money that’s left.
ADMATI: Yes. They said we’ll throw in $4 billion and give us a release and we’re out of here.
RITHOLTZ: And where is that right now?
ADMATI: It’s nowhere. I mean, the bankruptcy court is back to they had this sort of an agreement and it was thrown out, which is very rare.
RITHOLTZ: Right. That tells you how egregious the behavior was. It’s really rare. You have to really go out of your way to mess up for a bankruptcy court to save, that’s just too …
ADMATI: No. It wasn’t the bankruptcy court. They chose a particular bankruptcy court, a particular bankruptcy judge. This is shopping.
RITHOLTZ: Little form of shopping. Sure.
ADMATI: Exactly. Form of shopping. And then that judge was favorable to this master agreement.
RITHOLTZ: To the Sacklers. Right.
ADMATI: And gave them that and the other court said that doesn’t make sense.
RITHOLTZ: The appellate court said no judge.
ADMATI: And so, now, it got — the bankruptcy agreement is back at the bankruptcy court and the victims, by the way …
RITHOLTZ: Is it the same judge or is it a different court?
ADMATI: I’m not sure but the victims, anyway, were publishing saying, well, I wasn’t going to get very much, maybe I was going to get $3,000 or $1,000. And now, I may not get anything.
RITHOLTZ: Right.
ADMATI: So, there were even — they signed because it was so little they were going to get anyway. So, it’s all kind of pathetic.
RITHOLTZ: So, to me, it’s all a little lie to say full speed ahead, litigated it and we’ll let a jury figure out.
ADMATI: Well, the question is — so, here’s the question for the victims, can they actually go after the Sacklers? The Sacklers’ money is abroad. How can you actually find it? This is like the discussion we have today …
RITHOLTZ: Because you could still — because you could track that down and claw it back.
ADMATI: Well, it’s complicated.
RITHOLTZ: If it goes from the U.S. bank to overseas …
ADMATI: It’s complicated. I mean, that’s like how we now say, well, can Delaware Chancery Court make Elon Musk buy Twitter? It’s like, OK, the court can decide but what muscle does the court even have?
RITHOLTZ: I want to talk about Elon Musk and Twitter because the question becomes, are contracts enforceable? When someone says, can they make him do this? I don’t know. Those assets from the United States, he signed the binding agreement, it’s up to the court to just — to either enforce that agreement. You know how these things happen. In the 11th hour, there will be a deal cut because no one wants to take the risk of finding that out.
ADMATI: Well, the question is what actual literal power does Delaware court have on Elon Musk? He’s known for …
RITHOLTZ: Snubbing his nose at the rule of law.
ADMATI: For saying roles don’t apply to me.
RITHOLTZ: Right. And so far, they haven’t.
ADMATI: Mocking SEC.
RITHOLTZ: Yes.
ADMATI: And making a joke out of SEC, whatever.
RITHOLTZ: If the Delaware courts want to continue people incorporating in Delaware and enforcing contract law, then they have to really think about how they’re going to enforce this because if he walks away scot-free from this, then Delaware just lost a giant source of —
ADMATI: Well, yes. I mean, among my — the books, there is a book called “What’s the Matter with Delaware?” and — and so that’s quite — I mean, the fact — if you start going back to the origins of incorporation and why we even have corporate law in the state and why Delaware is sort of the state that matters to the whole world on in — on corporate law, that is — that’s the only business model it has for the state is these fees, you can become a corporation 10 minutes if you paid, it’s not that very much, without even identifying yourself.
And it’s like a whole other can of worms. Why is the U.S. so slow in basic, basic transparencies that you have more transparency in China?
RITHOLTZ: Which is shocking.
ADMATI: David Barbosa was able to track the wealth of the — of top Chinese through chains of corporate ownerships because for as little bit of money, you can find out the actual beneficial owners of every private corporation and that’s another corporation that you can pay a little bit more until you get to a person.
Not in the U.S. In the U.S., because Delaware likes it and because other states that compete with Delaware like it and because the legal profession likes it, we somehow sign on all kinds of agreements that are sort of for transparency after all the scandals, the Pandora Paper, the Panama Paper, and all of that, and then — and we’re the laggards in the world.
So, right now, finally, because the sanctions on Ukraine, et cetera, we have a law going through the ENABLERS Act and that is expansion of the bank secrecy law which is basically know your customer. But we had, FinCEN, that department in Treasury that gets all the suspicious activity report leak and we saw what happens to all these banks that file suspicious activity report and still process the transaction and nobody has enough resources in the — in Treasury to go over …
RITHOLTZ: Well, they file the report that lets them do the transaction.
ADMATI: Yes. And the money laundering is just pervasive. So, dirty money, when we talk about jurisdictions taking dirty money, you know, it’s a competition between U.S. and U.K. You have American kleptocracy on one hand, you have “Butler to the World” and all kinds of other books, “Moneyland” and kleptocracy, kleptomania, saying that U.K. is the winner on this. Which one is more of a home to dirty money?
“Butler to the World” is like we’re no longer an empire but we’ll solve, you want something hidden? You want taken care of? The butler will take care of it.
RITHOLTZ: Quite fascinating. So, we already talked about borrowing and how that magnifies risk. Tells us some of the dark side of borrowing and what we should be doing about that?
ADMATI: So, the use of debt to fund things, meaning I give you money, then I get an IOU from you, OK, is pervasive throughout the economy. I mean, it’s sort of a particular contract that gets signed all the time and a lot happens by using that funding, OK? And we seem to encourage it unnecessarily for buying houses or for funding corporations against other forms of funding.
RITHOLTZ: Well, when you say for buying housing, how else can buy a house?
ADMATI: Well, it depends if you want to subsidize it or not. In this country, we subsidize homeownership only if you borrow through taxes.
RITHOLTZ: Gotcha.
ADMATI: So, we don’t need …
RITHOLTZ: That’s deductible, right.
ADMATI: We don’t need that deduction. That deduction has got — it’s doing nothing good. If you want to subsidize home homeownership, choose the people you want to subsidize. And then, for example, you can give them a little tax credit for their down payment.
RITHOLTZ: So, in other words, instead of making the interest you pay on your mortgage deductible, you can make the down payment deductible and that would encourage …
ADMATI: For example …
RITHOLTZ: … more homeownership on most …
ADMATI: Yes. By specific people, not the rich people.
RITHOLTZ: … the bottom of the (inaudible).
ADMATI: Because right now, housing subsidies, even with poor people specific housing subsidies and vouchers that nobody takes in all of that, the most of the subsidies for housing go to rich people.
RITHOLTZ: Upper middle class. Yes.
ADMATI: I mean, that makes no sense. The more — the bigger the house, the bigger the deduction. It’s a regressive …
RITHOLTZ: Now, it’s been capped in a lot of places.
ADMATI: It’s been capped but it should be canceled and many countries don’t have it. Now, for corporations across the world, the historical mistake was made to allow tax deductibility of interest where debt funding is a funding expense, not a business expense. Should not be considered a business expense.
We should not favor debt over equity funding for corporations because it can always have access to their own profits and to investors because they …
RITHOLTZ: That’s global?
ADMATI: That’s global. That’s pretty global. Some countries try to fix that, so there are some papers about that tax bias …
RITHOLTZ: Who does it better?
ADMATI: Well, I think that Belgium’s tried to have some — there were other countries that were giving something to dividends and try to fix that bias, the tax bias. It is well known that tax bias of debt over equity is a distortion in the economy. The economies had a periodically starts and even Bloomberg here, Bloomberg View screens every so often to stop that. And somehow, nobody’s listening, so it’s just this persistent distortion that we never fix.
RITHOLTZ: In the United States, the bias towards debt over equity is distorting capital structures in Corporate America?
ADMATI: Yes. Because debt has a dark side precisely for that reason. The dark side of debt, I mean, I already mentioned the sort of addictiveness of debt at high levels, OK, which is especially if we’re banking because they are having indebted fundamentally and because they have all the safety nets that make their creditors more passive.
And they’d allow them to ratchet up their debt so I have a theory paper that I learned a lot from called leverage ratchet effect in The Journal of Finance 2018. Anyway, so what’s the dark side? When I teach this and I also teach undergraduates and by the way, I’m not even teaching finance and economic anymore, I’m teaching so into disciplinary that it’s listed in political science and it’s sort of has a lot of law. It’s very out of silo, it’s very, very cross disciplinary.
So, I took my class out of the finance listing. It’s kind of a general, kind of class. It’s called power in finance or business in government, power and engagement, those kinds of courses where I start with, like, human rights and I talk about corruption in all kinds of words that usually are not to be heard in a business school.
But anyway, back to the dark side of borrowing of debt, so as long as you keep your promise, everybody’s happy, OK? What if — so there are different terminologies that are important to distinguish. There’s the issue of default, what if you just don’t pay? You promise and you don’t keep your promise.
Now, stuff can happen. You might end up filing for bankruptcy but bankruptcy is a legal processor, so it has to be separated from default. It can happen before default. PG&E filed for bankruptcy, companies filed for bankruptcy without defaulting to seek protection from their creditors, OK?
So, bankruptcies like a legal option that is for — to kind of get from — from all the overhangs of debt that prevent you from breathing, OK?
RITHOLTZ: That’s more of a full — preemptive restructurings than …
ADMATI: It’s supposed to be.
RITHOLTZ: … than a winddown.
ADMATI: It’s supposed sort of for giving up for an individual, again, is like a restart were forgiving of taking too much that — but if you use it as a shield, like we discussed the Sacklers, et cetera, or if you start spinning office subsidiaries, it’s going to take off your talcum liability if you’re Johnson & Johnson using some two — Texas two-step trick or whatever or you’re Pfizer and they found you guilty of some fraud and you just put that …
RITHOLTZ: Not Pfizer. Did Pfizer get into trouble?
ADMATI: Yes, Pfizer. Yes.
RITHOLTZ: Really?
ADMATI: Yes. Ask Judge Rakoff about that.
RITHOLTZ: Well …
ADMATI: And he’ll tell you there are recidivist …
RITHOLTZ: In the southern district?
ADMATI: In the southern district, there are recidivist corporation. He loves to give the example of Pfizer even after the COVID and he says they would keep coming back. There would be a deferred prosecution, so why we keep deferring it? And then once I insisted they admit guilt, they send the liability, the criminal liability to a subsidiary and they’d fail that subsidiary and go — and completely continue.
RITHOLTZ: And does that shield the company from liability?
ADMATI: Yes. They …
RITHOLTZ: They’re spinning it out.
ADMATI: They manage to find tricks to shield from liability all the time or to suggest sort of shift the abilities around, kind of in between all the contracts and the covenants and all of it. So, there’s a lot of shielding going on. But in any case, that’s if you’re clever. If you are an individual or a small business it’s hard …
RITHOLTZ: You can’t do that.
ADMATI: It’s harder for you to play those games of liability shifting. Anyway, so the dark side is that you have that — your decisions, once indebted, are very different and potentially very inefficient relative to if you were just doing things on your — in your own money versus that board money and a little bit of your own money because you’re going to …
RITHOLTZ: So, let’s talk about that.
ADMATI: … excessive risks. You’re going to gamble for resurrection, take excessive risks so you buy in favor of risk, in favor of more boring and against certain boring investments because they benefit from those and that present any of those kind of first goes to the creditor because you’re after. So, you might be biased against making a boring business loan if you’re a bank because you want to go plain derivative instead.
RITHOLTZ: So, you talk about the problem of working with other people’s money, meaning whether it’s is banks …
ADMATI: The boring money.
RITHOLTZ: … or hedge funds or private equity, it doesn’t matter, they get to speculate with OPM, keep the gains. But if there are losses, it goes to writings.
ADMATI: Yes.
RITHOLTZ: So, how do we — how do we deal with that into our financial system? How do we make our system less fragile than it appears to be?
ADMATI: The first thing to do is to counter the forces of that intense desire to keep leveraging, which you know, I sometimes say the more they hate equity, the more I know they have too little of it.
RITHOLTZ: Right.
ADMATI: It’s like their intense hate of it says I can’t live unless you give me cheap debt to keep rolling my debt. I’ll default, terrible things will happen or whatever. So, they have always access to funding especially if you’re a too big to fail bank, the creditors will just not think especially if they’re lent to you with collateral in short term that — that they’ll be harmed and once they think they’re harmed, they’ll start running off, et cetera. So, you have fragile funding.
The only counter to that is not clever debt that converts to equity that nobody is going to ever trigger with, because we’ve seen that, is plain old equity. Your earnings, you know what I mean? You have profits that you pay out, how will the world be harmed?
For 10 years now, the book is almost 10 years old. We’ve been asking every so often macro economies, all kinds of people speak in this space, even academics, saying just tell me one thing as an economist. How will the world, society, be harmed if the banks retained earnings? They’re still their money. Warren Buffett …
RITHOLTZ: Their shareholders …
ADMATI: … never pays …
RITHOLTZ: Don’t get dividends. That’s that.
ADMATI: But you put the money the money to good use. Don’t burn it.
RITHOLTZ: Right.
ADMATI: Invest it. If you invested something safe, the risks to the shareholders will go down and they require return accordingly because we know finance risk and return are intertwined, risk and required return, why is Warren Buffett never paying dividends? Because he’s investing the money on behalf of his shareholders.
RITHOLTZ: Right.
ADMATI: So, are we not — so Warren Buffett himself, when he invest in banks …
RITHOLTZ: Although he is buying back stocks.
ADMATI: I know. Well, he — well, yes. Because that’s a more tax advantageous and …
RITHOLTZ: So, if all these comes back, it’s funny you keep — it keep circling around, it often comes back to what’s most tax advantaged, how have the regulators tee this up …
ADMATI: How you can shift the risk to somebody else …
RITHOLTZ: … and how have you manage other people’s risk?
ADMATI: If you can shift the downside risk to somebody and you pick the upside, that’s the bright side of leverage for those who take it if they can avoid the downside.
RITHOLTZ: Right.
ADMATI: So, the homeowner may or may not be able to avoid the downside, but homeowners levered up, took, cash out refinancing and re-levered and basically cash out refinancing when the housing price — when the house price goes up is the same as paying dividend when you make profit. It’s the same.
I ask my students, what’s the equivalent of cash out refinancing? Bethany McLean wrote the “House is Not a Credit Card” but that was the ad. Take your home on vacation before the financial crisis.
So, this is like the dividends that the regulators are allowing banks to keep paying even though they live on pathetically low equity, meaningful equity levels. Now, they don’t default, so you don’t see that they may well be insolvent. We just don’t know it because accounting disclosures don’t really show you what’s going on.
RITHOLTZ: So, how should we fix this? What should banks and financial institutions be doing differently? How should we change the tax code and the regulatory environment?
ADMATI: First of all, you have to ease out of that tax preferences. And secondly, you just against what their incentives are, if it’s a tax subsidy, it comes out of somewhere. I’m even willing to settle on the tax bill as in the amount of cash that they owe that’s a function or that’s the same as right now. Except they didn’t lever as much in order to get that same tax bill. In other words, to lower their tax bill because it’s the fragility of that overhang, the inefficiency of that overhang, that is making the entire system fragile because that — in the dynamics of contagion which we explained, the banking dominoes, one defaults on another like we’re seeing in crypto right now.
RITHOLTZ: Right.
ADMATI: And then there’s the information contagion where I’m now worried that this whole sector is going to fail. Lehman fails, is the next thing to fall is some other banks in the same business and that was, by the way, a concern of some people in the Fed even like Kevin Warsh after Bear Stearns was bailed out, basically.
RITHOLTZ: Well, that’s because they owned the same …
ADMATI: The same thing.
RITHOLTZ: … crap. Right. And so, when it went down …
ADMATI: And they were exposed to one another — exactly.
RITHOLTZ: People talk about Lehman like it’s a domino that sent it off. I love to describe Lehman Brothers as the first house in the trailer park that the tornado destroyed.
ADMATI: So, I have visuals in my TEDx talk that basically have tall buildings and I color code them red for debt, green for equity, very little, and then the green disappears and they topple on one another and then there’s Uncle Sam kind of trying to say …
RITHOLTZ: So, it all comes back to insufficient equity relative to way too much debt.
ADMATI: Yes. That’s just the most obvious thing. That’s like the no-brainer thing. So, when you look at as I came and looked at it, I’m like, why are we here? there’s a simple, like, costless fix. You just re-arrange the financial claims in the economy so where the upside, the people with the upside also bear the downside. That’s the way it’s supposed to be.
It’s not supposed to be privatized gain, socialized loss because it’s supposed to be — and this is a basic thing, bipartisan in everything.
RITHOLTZ: Didn’t Dodd-Frank fix some of this or it was reputed to have fixed some of this or was it watered down that much?
ADMATI: So, Dodd-Frank — so let’s just be clear on what Dodd-Frank was. Dodd-Frank was a massive law with 1,000 pages. Dodd-Frank gave authority to regulators. Dodd-Frank gave, in Title I, told the Fed to solve the too-big-to-fail problem to do what whatever they need for financial stability and the Fed is still failing to do that.
RITHOLTZ: Really?
ADMATI: Yes.
RITHOLTZ: So why have the banks been relatively stable for the past decade? Is it low …
ADMATI: Well, I mean, just because they don’t implode doesn’t mean they’re healthy.
RITHOLTZ: I guess, I guess. Just if you don’t drop dead doesn’t mean you’re not sick.
ADMATI: If you’re bloated and inefficient and taking much of more of the economy than we need because you can, and meanwhile you’re paying yourself and all these people all the salaries where we should have a more efficient financial sector and you said it’s so bloated and so profitable, it comes out of out of somewhere. So, to me, the banking sector is not healthy just because it exist and profitable. Not at all.
RITHOLTZ: Right. It hasn’t died doesn’t necessarily mean …
ADMATI: Yes. You’re overweight and unhealthy but you have the feeding tube. You know what I mean?
RITHOLTZ: You’re still alive. Got you.
ADMATI: Whatever analogy.
RITHOLTZ: What do you think is going to happen — so I’m not going to ask you for a rate forecast or what the Fed’s going to do. That ear of cheap capital and free money and zero interest rate clearly is coming to an end, are we — is the tide going out and we’re going to find out who’s been swimming naked?
ADMATI: In banking, I don’t think so. For banks, actually, i higher interest rates could be very profitable.
RITHOLTZ: More spread.
ADMATI: Yes. More spread. So, they’re actually having some trouble with squeezed yields. So, unless …
RITHOLTZ: So, even to push back to that, hey, they weren’t making big spreads on let lending and they still managed to not implode, if they could survive zero, they should well at two or three percent?
ADMATI: But these banks have so much — so many ways to make money. I mean, look at the COVID? OK. Look at how they made money through COVID? With the supports to everybody, I mean, banks with a vehicle through which we gave PPP loans. And what was PPP loan but a windfall for the banks. They were given, I think, they took the money at the quarter percent and were paid one percent. So, that’s a spread right there …
RITHOLTZ: That’s right.
ADMATI: … on hundreds of billions of dollars. And there was fees
ADMATI: It was guaranteed and forgiven and so they took no risk, they did hardly credit ordinance because we were rushing to give the money out and they were not liable for checking the papers because it was all so rushed. They gave a lot of it to their favorite clients and then we needed to give more of it.
RITHOLTZ: There was a lot of fraud also built into it.
ADMATI: That too. And a lot of companies shouldn’t have — it wasn’t meant to got and then the Fed was standing ready and started buying corporate bonds and that was — it’s huge debt spree for the entire corporate sector which, again, the investment banks benefited from all these debt party that went on. And so, it was a wonderful life and during COVID in the banking sector.
RITHOLTZ: It’s funny you brought that up because in the United States, we have a tendency to ask the corporate side to do things that should be government business. So, if the whole idea behind PPP was to keep people employed in small and medium businesses, why get the business involved? Why isn’t that directly from the government?
And the same thing with healthcare. Why is so much healthcare through businesses instead of directly through some government entity? Please leave businesses out of it. Do — let the government do its responsibility directly with the citizenry.
ADMATI: So, around — at the start of the financial — of the COVID crisis, there were — there was a letter organized, a few hundred academics, in the law finance economics, signed it, telling the government before the — right around the time of the CARES Act, first one, to not give money to corporations. To give it to people who need it.
So, in other — and part of it was logistical in this country because you basically — you have the data. I mean, IRS …
RITHOLTZ: Right. Of course.
ADMATI: … and everything, you — and Social Security.
RITHOLTZ: Everybody gets a W-2 payroll …
ADMATI: Exactly. So you …
RITHOLTZ: … or Social Security.
ADMATI: You take over. That’s what governments did in Europe. You take over the payroll. So, this way, it’s not at their discretion to kind of their good will to …
RITHOLTZ: Right.
ADMATI: Now, they can’t hire again in the airlines, et cetera. So they came for bailout and the airlines are classic example after having paid every — virtually everything in dividends right before that. And now they’re …
RITHOLTZ: Right. They would have plenty of money if they were a little more circumspect.
ADMATI: And for airlines in particular, bankruptcy has traditionally work great. You don’t ground the planes. You want them to fly.
RITHOLTZ: Everything keeps flying. Right.
ADMATI: And you just renegotiate some contracts, we have plenty of time to do that during the crisis. Why are we — why are we bailing out the investors that just got a huge reward? We’re not, like, effectively at least zeroing them if not clawing back, some of this money.
RITHOLTZ: Right. The old joke about airlines as they haven’t been profitable since Kitty Hawk. But let’s stick with government payments to corporations. We saw something very similar in the financial crisis where the banks who were bad lenders were bailed out but really the borrowers didn’t see there was some relief but not a lot.
ADMATI: Yes. So, there was, clearly, a huge bias towards bailing out the banks, foaming the runway, all of that and the person who wrote most eloquently about this is Neil Barofsky, of course, “Bailout.”
RITHOLTZ: Even more specific.
ADMATI: Neil Barofsky wrote a book about bailout. He was the inspector general off the TARP, the Troubled Asset Relief Program. And he was complaining in describing, and other people did too, how little the programs did. I mean, remember, from that, they bailed out AIG, they bailed out the auto manufacturers, but homeowners didn’t relief and it had collateral harm.
So, the programs for homeowners were voluntary to the lenders. Now, the loans were securitized. So, now, there’s no lender to negotiate with and it’s much more efficient to renegotiate the loan than to two foreclose. Instead, you had a massive housing crisis in which there were a lot of foreclosures, a lot of people misplaced, very traumatic expense for a lot of people, whose mortgages should have been restructured basically.
And again, it was the lenders that were doing it and then the lenders did — just didn’t choose. I mean, you had, in the accounting of, say, Citigroup, you had them not want to — not want to restructure second mortgages which were clearly or know what to declare on their accounting which were clearly total loss because there were second junior mortgages, even if — so …
RITHOLTZ: But they were rescued. They were bailed out of those.
ADMATI: Exactly. And so, they were not even acknowledging their losses. I mean, you could see on their book-to-market. I mean, you could see that they were exaggerating their books hugely.
RITHOLTZ: And for people who not — may not remember Neil Barofsky, he was the NYU law professor …
ADMATI: For a while. Yeah.
RITHOLTZ: … who was the special inspector general for the Troubled Asset Relief Program, the TARP.
ADMATI: And he wrote this book about how they bailed out Wall Street and left Main Street and are now …
RITHOLTZ: I’ve been begging Neil to come on the show.
ADMATI: Yes. He’s a partner in a law firm and one of the things he did afterwards was Ben Lawsky who was the regulator in New York …
ADMATI: Yes. And employed him for a few years. He was a full-time manager of Credit Suisse. Credit Suisse being now, out one of the poster child. I mean, if you want to talk about reckless banks, you had …
ADMATI: Credit Suisse right now, but Deutsche Bank being the poster child. And …
RITHOLTZ: They all seem to be slowly recovering from their original on-life-support status.
ADMATI: You’re a zombie …
RITHOLTZ: Right.
ADMATI: You’re a zombie and we feed you enough and we give you time and you come out from the dead.
RITHOLTZ: Fifteen year. Ten years. Absolutely.
ADMATI: Yes. So, if you never can die, you come back.
RITHOLTZ: Well, that’s no surprise and they’ve all essentially come back. So, one last piece of research of yours I have to ask about, it takes a village to maintain a dangerous financial system, why does it take a ? How many entities have to be involved to keep finance dangerous?
ADMATI: So, I will talk a little bit about this. This was my, kind of, my own summary of my experience over the five years in which I really was devoted entirely to this little policy battle where the book and writings that we did afterwards were sort of debunking all — a whole set of flawed claims, what we call. We call them “Banker’s New Clothes” but it’s not just bankers, it’s policymakers, it’s even academics, who say things that fall under the category of fallacious false or then kind of true but irrelevant …
RITHOLTZ: Knowingly false or just ignorant or both?
ADMATI: I don’t know what goes on in people’s heads.
RITHOLTZ: Right. I do and it’s insane.
ADMATI: I really don’t. I can say, I can say this person should know better than utter — that nonsense. Sometimes I’m told people whisper in my ear, they don’t understand and I’m like, wait a minute, bread and butter finance, they don’t understand? Leverage and risk, risk and return, they don’t understand, that doesn’t make any sense to me.
I write open letter to JPMorgan Chase, reading this letter to shareholders. I write all these different op-eds. I just did this four, five years straight including a year and a half in the bunker writing the book. And in 2015, I decided, OK, what happened to me here? Why it’s so difficult? And who did I meet along the way who kind of led to this situation that I encountered?
And so, at the time, 2015, two movies came out. I was actually in New York for a month or two staying at NYU and was kind of in town for various things. There are many stories I can tell you about that period. And the two movies that came out and competed for the Oscar that year were “The Big Short” and I came to see it with Adam McKay and some of the — pre-showing because he wanted to see what finance people, academics, will say to the movie. And later, he recorded his session with us because people were asking him what to do.
Of course, he finished the book why nobody goes to jail which was kind of most of what he showed was legal. So, that’s kind of not the end that Michael Lewis had in the book. Michael Lewis, by the way, in the book, “The Big Short,” ends by saying the problem was not that Lehman was allowed to fail, the problem was that Lehman was allowed to succeed first.
RITHOLTZ: For as long as it did.
ADMATI: Yes.
RITHOLTZ: Right. Exactly.
ADMATI: So, he went back to partnerships moving to limited liability corporations and becoming reckless with other people’s money. But anyway, so I was asked to write an essay for a book that was edited by a philosopher that was called “Just Financial Market? Finance in a Just Society.” So, it was about justice.
And so, I had to connect what I’ve seen in finance in the banking area to some sense of justice, of who inflicts injustice. And so, the way in which people cause harm is sort of by doing and by not doing is by being willfully blind by all these terms from psychology about how you can cause harm and sleep overnight.
So, it was basically I started asking why has it been hard to get through with my simple message? Who were all the people who were trying to be on the other side of this? So, you start with the bankers. They benefit. You then go to all the different private-sector gatekeepers, the accountants, the credit rating agencies, consulting companies that a lot of people that want the regulation to be very complicated because it creates a lot of jobs doing stress test and all kinds of fancy things even if they’re not really good.
On and on, the people are enabling the situations, so the keyword is enablers, OK? Now, the title came from the movie “Spotlight” which was the other movie that came out. “Spotlight” was a movie about sexual harassment in the church, catholic church, and it was about a journalist in Boston and covering how sexual harassment in the church persisted and how, once they investigated the abusers moving around the system …
RITHOLTZ: It just move them to a different church. Right.
ADMATI: … they were able to see the problem is much more systemic than the one — one at a time little story.
RITHOLTZ: And that’s the parallel between the twoo.
ADMATI: In the story — in the movie, “Spotlight,” the lawyer, to some of the victims, who, of course, even if there was a settlement, they were told to shut up, just like a lot of settlements that I’ve been looking at.
RITHOLTZ: NDAs. Sure.
ADMATI: All the NDAs. The lawyer says to the journalist, if it takes a village to raise a child, it takes a village to abuse a chilid.
RITHOLTZ: Quite amazing.
ADMATI: Yes. And it takes a village to raise a child is the title of — it’s an African saying that Hillary Clinton adopted for a title of her book, takes a village to abuse a child is all the enablers who look away, all the people who kind of make the situation a wrong, persist. And you know, go to all kinds of things. Go to Weinstein, go to a lot of wrong things that persist. They were enablers along the way.
So, I wanted to see the enablers in my world in which main — maybe not even crimes were committed but there was sort of legal deceptions. There was a capturing of the regulators. There was sort of, capturing of the politicians. There was confusing the politicians. It was confusing the public who all did that.
And so, I went all the way to academics, all the way to people whose job is to the regulators and their narratives and basically said, here is what they’re saying here is why it’s flawed and wrong and misleading. And this — it enables this system to persist. At the same time, there was a book by a Dutch journalist who did, called Joris something called “Swimming with Sharks” who’s a bad banking culture and all he did was he interviewed a bunch of people in the City of London about their jobs anonymously.
And he was just trying to map out how people felt about their jobs and who’s getting paid and who’s getting fired and whether they think it’s fair relative to their high school friends or whatever. And he became so alarmed with the financial system that he started having these analogies of an empty cockpit, oh, my God, all these people …
RITHOLTZ: Nobody’s (inaudible).
ADMATI: … nobody’s taking — I told him — we took a walk in London along the river and I said, you know what? It’s worse. I mean, he’s an anthropologist by training. I come from the ivory tower in finance down to the ground and we meet in the same place. This is crazy, OK? And I said to him it’s worse than an empty cockpit. He has a nightmare where he walks in the cockpit it’s empty.
I said, you know what? The pilots of the airplane are paid to do flips and to fly low and they have their own parachutes, so they don’t care about the passengers. So, it’s kind of worse than people who control the system benefit from its fragility. And so, you can’t fix it until you — that’s what the book tries to do is educate the public.
So, right now, it’s going to be 10 years since the book — in February 2023, it will be 10 years — and we are considering, right now, republishing this book in 2023 with a sort of one epilogue chapter, maybe a preface, explaining how the book still relevant to COVID bailouts, to crypto which we didn’t get to discuss.
RITHOLTZ: We’re going to talk about that in a minute.
ADMATI: OK. We — I’m happy to talk about it. And to the fraying of democracies.
RITHOLTZ: So, before we get to my favorite questions, I have to ask you my curveball question which is you’re an advisor to HBO “Silicon Valley,” a show I just adored. Tell us about that experience. How did they find you, other than the fact that you’re at Stanford and what’d you do for them?
ADMATI: So, how they found me was that they originally found my neighbor who’s an electrical engineering professor and he is — his last name is Weissman, so he is the one after which the Weissman score, compression score, is and …
RITHOLTZ: Really? On the show, they created this …
ADMATI: On the show …
RITHOLTZ: … new compression algorithm.
ADMATI: And this was from some research because the — this coproducer, Jonathan Dotan, was sort of scouting the Silicon Valley to kind of find a believable story to capture the spirit of Silicon Valley, and he, looking for storylines and concepts and then he came across this and then this professor and a couple other professors from computer science and engineering help the shall show be as believable as it was.
Now, as it went through and it was all out there in the garage and all this stuff, it got to the sixth season. Now, my neighbor said to me, knowing what I was doing about financial system and my general interest in corporations and society, he said I got — you got to meet this guy, ponytail and we’re sitting around with coffee.
And later, he says, you ought to teach a course with him and that was when I became, I said, you know, I’m curious about this sector. Guy knows everybody, OK, because everybody was cameo in “Silicon Valley” and he knows about the history of the Internet and all of those things and he’s not an economist, he’s an anthropologist by training and just sort of a producer, writer.
And so, we embark on this MBA course and while they are writing the sixth season, so they end up putting me as an adviser. I mean, they didn’t pay me anything. I just signed a bunch of paper and they gave me $200 which is like a bottle of wine for all of these just because they didn’t want me to later claim that I gave them some idea, copyright, because they — it was impacting their coverage of pseudo-governance issues, mission statements. They mocked mission statement of plagiarism of mission statement. These kinds of things because it’s like (bleep) mission statement.
So, talk is cheap, as I said. And so we taught this course to MBA entitled Is the Internet Broken? And then, this was spring, quarter of 2018. Something like that.
And then, so as we were doing — in the fall, they finished, they were showing the thing and they were filming, like early in the fall, they were filming the last episode. And so, he calls and says, OK, you guys, I got them to fly four of you down to L.A. and be cameo in the very last episode and hang out here for the day and see how we film it, see all the scenes, see the prison scene, see this — all this different things. It was a — it was an abandoned, kind of car manufacturing of some sort.
It was just like a bunch of like warehouses where they had it. I’ve never seen a show, a fictional show being filmed. The cameras, all the rooms.
RITHOLTZ: And they wrapped in 2019, right? The end of 2019?
ADMATI: That was — yes, exactly. So, this is 2019 spring into fall. And so, we were there. We flew down to L.A. and we — we had to bring our cap and gown if we had it or they would put it on us. They had a whole thing of cap and gowns for this graduation thing event that we were sort of part of.
So, we — they had all these people there recruited for the day to be just sitting there and then — and as long as you don’t utter a word, so if we uttered on word in the movie, we would have to be unionized.
RITHOLTZ: Gotcha. So, you got to just …
ADMATI: But if we were just silent, then they could film us …
RITHOLTZ: Then you’re an extra.
ADMATI: … and we could be there. So, they had another scene that they filmed in the hallways of the sort of Stanford University offices and we got whiteboards to decorate. So, I have a certain corner in the whiteboard behind Middleditch when he was kind of reflecting at the very final scene and we saw it being filmed and then we hang out with him.
So, it was kind of my reward. I’m like, when I teach banking, I don’t get to have so much fun. But when I taught about the Internet, I actually got to see — and my point there was only here in this whole discussion is, I’ve come to appreciate how important media is, all forms of media.
So, even in movie, it shapes how people think.
RITHOLTZ: Perceiving. Sure.
ADMATI: There was a scene there where the guy’s in front of Congress and then he rips the mike and this all thing and that was modeled after Mark Zuckerberg going to Congress. He kind of looks like him.
RITHOLTZ: So much fun. So, let me jump to our speed round, our favorite questions, which will blow through pretty quickly starting with aside from Silicon Valley, what have you been streaming. Tell us what’s kept you entertained?
ADMATI: So, I’m a little bit of a late comer to finish it but I’ve loved “Succession” which I finally finished very recently. And I’m intent on finishing “Borgen” because …
RITHOLTZ: “Borgen”?
ADMATI: “Borgen” is Danish. It’s like the “West Wing” for Denmark. And it had this female foreign minister, et cetera. Anyway, it’s gone a few season off Netflix series “Borgen” and so it’s very good. I mean, I know there’s “WeCrashed” and other things. So, but that’s enough for that.
RITHOLTZ: I just started “WeCrashed,” it’s actually very good.
ADMATI: I heard that.
RITHOLTZ: I’m halfway through it.
ADMATI: My co-teacher tells me.
RITHOLTZ: It’s — and I love …
ADMATI: But I’ve read so much about WeWork, I’m kind of sick of it especially in Israeli (inaudible).
RITHOLTZ: I love the book “Cult of We.”
ADMATI: “Cult of We.” Yeah.
RITHOLTZ: And the whatchamacallit? The show seems very true to that.
ADMATI: WeCrashed and there was this podcast. Yes.
RITHOLTZ: Yes. Tell us about your mentors, who helped to shape your career?
ADMATI: So, this adviser, Steve Ross, at Yale, was very important to getting me interested in finance. And in some respect, in the sort of cosmic view of where I am today and my transformation of my — where he was there, unfortunately he died a few years ago but he was there to sign my petitions and then encourage me all the way to “It Takes a Village” was there to kind of tell me I’m not going to made when I hear all these nonsense and to approve of what I was doing, even though, in some of my criticism of academics, I criticize some of my sort of academic brothers who are also his students but he sided with me. so, that was very meaningful to me.
Yes. So, he was my main adviser who got me — because right now, for knowing all the finance I know, I’m able to call the book (bleep).
RITHOLTZ: That’s great. Tell us about some of your favorite books. What you reading now and what your all-time favorites?
ADMATI: Oh, my God. So, my all-time favorite is “The Little Prince.” That’s just the book. I’m reading a lot and now I’m listening so that makes it faster because I don’t read as fast as I would like to. But I have really lots of books.
Right at the moment, I sort of finished Direct (ph) and I was like “The World for Sale” and freezing order to discuss flying blind on Boeing. “Sickening” is a book on the health care sector and how we know all our health care is very scary, worse than banking, into some extent. “American Kleptocracy.”
Right now, I’m reading a book very close to home called “Who Killed Jane Stanford?” which, like, woah. I mean, all the stories we tell at Stanford and that history of Stanford going back to the 19th century in Gilded Age and the Stanfords, woah.
So, that’s a history professor at Stanford who wrote a book “Who Killed Jane Stanford?” Jane Stanford was very important to the creation of Stanford. But right now, of course, Stanford is way off from what she wanted. And yesterday, I got “The Bond King” from Mary Childs. So, that’s my next book.
RITHOLTZ: That’s a great list you …
ADMATI: So, a whole bunch. Yes.
RITHOLTZ: That’s a really good list. What sort of advice would you give to a recent college grad who is interested in a career in either investing finance, academia, or technology?
ADMATI: My first advice, because I’ve learned it kind of the hard way, is watch out for the assumptions you’re making and other people are making.
So, when people say things, it’s often implicit assumptions they are making and then some bad assumptions can take you down. Even LTCM, with all the brilliant people, went down on bad assumptions. So, bad assumptions are very dangerous.
And then, of course, you have to kind of be careful not to maintain the big picture, to be aware of losing yourself in certain activities. So, maintain the big picture and check for assumptions, kind of my main advice.
RITHOLTZ: Good advice. And our final question, what do you know about the world of banking and finance and regulations today that you wish you knew 30 or so years ago when you were first getting started?
ADMATI: I had no idea about how much politics, laws, and law enforcement matter to economic outcomes. I just lived in the little bubble of economics where we make assumptions. And when I sort of realized what was going on in banking, I started questioning all the assumptions that I made before. And it’s been my sort of journey ever since, it’s like, that’s sort of interesting. Is this true? And what’s actually going on?
So, I’ve become a sort of real explorer of what happens when I don’t make the assumptions that I make or when I question people’s assumptions.
RITHOLTZ: Did you spend any time researching the Canadian banking regulation? Because when I was writing “Bailout Nation,” that was my compare and contrast. It’s so different from the U.S. system.
ADMATI: It is. And I know a little bit about it. But it is a very different system because the U.S. is a very fragmented system and the Canadian system is basically a system of five banks or something like that, all pretty tightly regulated, but also very profitable.
So, essentially the way — one of the ways I formulate the difference is that we — we subsidize debt for banking and they essentially subsidize equity by giving them a big charter value because they’re — because they’re so entrenched in their oligopoly.
RITHOLTZ: Quite fascinating.
We have been speaking with Professor Anat Admati. Thank you, Professor, for being so generous with your time.
If you enjoy this podcast, well, be sure and check out any of our previous 400 or so. You can find those at Spotify, iTunes, wherever you get your favorite podcast from. We love your comments, feedback, and suggestions. Write to us at mibpodcast@bloomberg.net. Sign up for my daily reads at ritholtz.com. Follow me on Twitter, @ritholtz.
I would be remiss if I did not thank the crack team that helps us put these conversations together each week. My audio engineer is Justin Milliner. Paris Wald is my producer. Sean Russo is my head of research. Atika Valbrun is my project.
I’m Barry Ritholtz, you’ve been listening to Masters in Business on Bloomberg Radio.
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