Friday, May 8, 2009

Economics: No More "Too Big to Fail"

KENNEWICK, WASHINGTON - With all of the outrage being expressed on radio talk shows across the political spectrum over the financial situation in the United States, one aspect that I have been surprised to hear expressed only very infrequently has been the concept that a business that is "too big to fail" is too big to be allowed to exist. In other words, the government should not allow a company to grow so large that poor decisions at that company would have a devastating impact on the overall economy, so that the only alternative would be to spend government money to avoid the collapse of the company.

I believe I first heard this concept on the radio on the Dave Ross Show from KIRO-FM, but early in the bailout cycle it was expressed by several progressives. I hadn't heard the idea again until Gil Gross of KGO in San Francisco brought it up again this week. (For the next week, this hour of the Gil Gross program is available in the KGO archives.)

As on the Gil Gross show, right-wing economists insist that this is not a valid perspective. They claim that there is no analogy between the size of a company and monopoly status, which they usually agree is a good reason to break up a firm. The obvious example they use is General Motors--it clearly did not have anything near market dominance in recent decades and there is little reason to believe that without its economies of scale that it would have performed any better in marketplace. They claim that a bank's quality of service has little to do with its size and everything to do with its management.

It seems to me that they are missing the point. I agree that there can be solvent banks of large size providing good services to consumers and businesses. That isn't the point. The point is that if they do fail--or make such bad decisions that they are on the road to failure--they don't just bring down themselves, they drastically impact the financial system for everybody, not just the investors in that bank.

This seems to me to be a much simpler case of those who normally argue for free markets effectively arguing against them. By arguing that banks should be allowed to become as large as the market will allow, they are effectively arguing that it is okay for the government to rescue large banks that make poor decisions, since that is the political reality when a Goldman Sachs-size company is on the verge of collapse. If the financial institutions had not been allowed to become that large, then it would be politically possible to allow the free market to work and allow companies making poor decisions to collapse. The free market is actually enabled by regulation on institution size, not inhibited by it.

There is no reason that a company needs to be allowed to become "too big to fail". It is amazing that there is no talk of trying to prevent this outcome, another sign there doesn't seem to be much seriousness about preventing a repeat of the current economy.

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