Too big to fail?

2009/03/30

Much has been said in the past few months WRT companies that are “too big to fail,” and this argument is being used by the current presidential administration as a justification for continued Federal bailouts for various companies. Unquestionably, these companies are too big to fail, i.e., their collapse would exacerbate what is already a very substantial economic crisis. Perhaps a more important question, however, is whether we, as a nation, should allow companies to become too big to fail, and, if so, should we allow companies that already have such status to remain so large. One has to wonder if all the bailouts flying aroun are only encouraging these companies remain as bloated and inefficient as they are; one also has to wonder how sincere the administration is WRT their claims that they oppose the status quo.

Most of us learned in school about the “anti-trust” regulation that supposedly exists to prevent monopolization of a given industry; in truth, this is a common misconception. The Sherman Antitrust Act (U.S. Statue 29 Stat 209) was intended to prevent the harmful practices that a monopolizing company could engage in (price-fixing, unlawful anti-competitve business practices, etc.), but not to prevent monopolies per se. [1] Additional legislation generally bears this out, [2] and generally speaking, it is clear from the current economic climate that “benevolent” monopolies (or companies that lay claim to substantial portions of the market) do not violate these various laws. Additionally, the Federal Trade Commission (FTC) was created to “police” antitrust-related corporate activities, but again, its scope is generally restricted to preventing the aforementioned abuses within monopolized industries, not necessarily preventing monopolies in the first place. [3]

It is clear, therefore, that existing legislation does not prevent companies from growing to a size that makes them “too big to fail”. The question, then, is can there be such a thing as a “benevolent” monopoly? IMHO, it is possible, but it is probably not in the best interest of our nation for such companies to exist. The current Whipping Boy of the Day™, American International Group, provides a good case study for the danger posed by such companies. While none of the actions that AIG at large or its troublesome division (AIG Financial Products) did were illegal at the time they engaged in such practices, it is, of course, clear from the results that their actions had broad negative effects on the entire national economy and that of the entire world (though, in all fairness, I care far less for the latter than I do for the former). Granted, I am reasonably confident that these actions were not malicious in nature, [4] but the damage that resulted is certainly not “benevolent”, either. My thought on the matter is that if a company grows to the point that the actions of a handful of their executives could potentially wreck the national economy and endanger the financial stability of countless citizens (those who responsibly paid their debts and invested wisely), then this is a company that should not have the size and scope that would allow such a situation to occur.

It has been argued that antitrust legislation may be harmful to business innovation, and that less regulation would be more stimulative of innovation than coerced competition. [5] Unfortunately, not all innovations are good ones; no one can argue that the mortgage-backed securites scheme was not an innovative one. The results of this particular innovation, however, are obviously less than ideal. One could also argue from the opposite side regarding the American Big 3 automakers; these three companies have swelled substantially in the past few decades, supposedly benevolently. Fair enough, but it would also be difficult to argue that these same companies have been at the forefront of innovation in the automotive industry. [6] I think it is fair to argue, in both of these cases, that we should not simply allow these such companies to do whatever they want, and then sit by idle while they demand support from the Federal dole when their own actions led them to their current calamitous situations.

I’m not a fan over-regulation, but I think that it is clear that some regulation, even if it makes corporate activities a little less efficient, is far preferrable to none. Just as individual people need some form of government to protect them from the dangers of unbridled human nature, [7] our national economy needs some form of protection from the negative consequences of unregulated business practices. I have no doubt that there are ways to balance a free-market economy with protective measures that would prevent a crisis (such as the one we currently face) from happening again; regardless of whether or not one agrees with the scope of the Federal government’s intervention thus far (I don’t), I think we can all agree that we cannot afford another such crisis in the future.

Notes:

[1]: Full text of the Sherman Antitrust Act as part of Title 15 of the U.S. Code available here. From the U.S. Code Collection of the Legal Information Institute at Cornell University Law School.

[2]: See, for example, the Clayton Antitrust Act (Title 15, U.S. Code, Sections 12-27). From the U.S. Code Collection of the Legal Information Institute at Cornell University Law School.

[3]: Full text of Title 15 of the U.S. Code, sections 41 thru 58 available here. Section 45 defines the scope of the FTC WRT unfair methods of competition (or the lack thereof). From the U.S. Code Collection of the Legal Information Institute at Cornell University Law School.

[4]: “Never ascribe to malice that which is adequately explained by incompetence.” Commonly attributed to Napoleon Bonaparte; I have seen at least one similar statement in a short story by Robert Heinlein.

[5]: Alan Greenspan, for example, argues strenuously against antitrust legislation in his memo, Antitrust. I suspect that Greenspan still believes that his arguments are valid, though in our current economic climate, there may be fewer adherents to his ideas than there once were.

[6]: Granted, the automakers have been mostly responding, knee-jerk, to the demands of American consumers, but I think that it is still fair to criticize them for not making greater efforts to produce move innovative vehicles, given the global fossil fuel climate, and greater competition from foreign brands.

[7]: See Chapter XIII of The Leviathan by Thomas Hobbes. I’ve posted some pertinent sections here.

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3 Responses to “Too big to fail?”

  1. MI Says:

    A minor debate has broken out in the econoblogosphere re. the desirability of big banks.

    Pro-bigness:

    http://brontecapital.blogspot.com/2009/03/watch-those-baskets-why-citigroup.html

    http://brontecapital.blogspot.com/2009/03/case-for-letting-bankers-rip-us-off.html

    http://www.motherjones.com/kevin-drum/2009/03/too-big-fail

    http://www.marginalrevolution.com/marginalrevolution/2009/01/itty-bitty-banks.html

    Against:

    http://baselinescenario.com/2009/03/27/big-and-small/

    http://www.interfluidity.com/posts/1238294532.shtml

    http://www.interfluidity.com/posts/1238216719.shtml

    I tend to prefer shrinking banks down to size (although given that WaMu was resolvable via FDIC processes, methinks banks of that size may be acceptable).

    It should be noted that smaller banks are only one aspect of the solution (albeit an important one). Competent regulation, to limit risk-taking by such banks, is another. Absent such regulation, it’s entirely possible for an entire financial industry (e.g., S&Ls) to go over the cliff.

    OTOH, even absent competent regulation, banks do have incentives to lend & borrow prudently. With more (and smaller) banks, you’re more likely to have at least some that remain sane even as their brethren imitate lemmings.

    • seeker312 Says:

      I think it is important to note that many of the smaller banks around the nation are still quite healthy (and, in some cases, almost completely unaffected by the credit crunch or the MBS debacle). The argument pro-big banks WRT profitability runs both ways; after all, the geniuses who created all the wacky dealings that brought our economy to its knees did so because these transactions were enormously profitable – and, as such, they had a vested interest in continuing these schemes for as long as possible, even though they were based on specious assumptions of market trends.

      I also agree that competent regulation is necessary to ensure that such a crisis does not threaten us in the future. The current crisis was caused as much by the lack of regulation and competent oversight as it was by the shady dealings of the financial giants.

      And, of course, there is also the compelling argument that irresponsible actions should not be without consequence. Government bailouts sans critical analysis of the successes and failures that led to the need for said bailout only serve to uphold the status quo, without regard for the wisdom (or lack thereof) of keeping the recipient institution alive. It should also be noted that all of the outrage and clamoring for blood from these institutions did not happen until after the bailouts were initiated; clearly, our representatives did not feel it was necessary to apply negative consequences to these institutions until after everyone got pissed off about it.

      • MI Says:

        Methinks smaller banks will be seeing their own waves of failures in the years to come, thanks to CRE, credit cards, C&D loans, & mortgages like Alt-A & Option-ARMs (many of which were held in portfolio rather than securitized). The difference is that a smaller bank can be brought down via normal FDIC procedures w/o crashing the entire system. The same cannot necessarily be said of TBTF institutions.


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