Loss of Large-Bank Franchise Value Poses Growing Risk
In this alert, we analyze an influential paper released late last week by former Treasury Secretary Summers and Natasha Sarin of Harvard arguing in part that the largest banks are not safer than they were before the crisis – indeed, perhaps even riskier – despite all the new regulations.  Taken by some as a call for still tougher rules, the paper in fact suggests that still higher capital standards or more stringent stress tests could backfire by making large U.S. banks even riskier.  This conclusion is based on the measures used to judge bank risk – principally market capitalization and certain risk spreads – most of which show that investors do not reward U.S. banks for all the new rules.  Although some academics have suggested that investors do reward banks for resilience through reduced cost of capital, we have long asserted that investors invest in banks for the same reason they invest in light-bulb companies: to make money.

Daily092016.pdf