SEVEN

Is Equity Expensive?

The banker sitting next to me was lamenting the profitable lending opportunities being passed up by capital constrained banks, when I broke in to ask: “Then, why don’t they raise more capital?” . . . “They can’t,” he said. “It’s too expensive. Their stock is selling for only 50 percent of book value.” “Book values have nothing to do with the cost of equity capital,” I replied. “That’s just the market’s way of saying: We gave those guys a dollar and they managed to turn it into 50 cents.”

Merton Miller, 1990 Nobel Laureate

THE CONVERSATION REPORTED by Merton Miller and quoted above focuses on a key question for banking regulation.1 To bankers it seems obvious that equity is expensive.2 But what does this statement refer ...

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