9/03/2009

Is any firm really "too big to fail"?

I came across an article in the Harvard Business School Working Knowledge research site discussing the economic impact of large financial firms and whether or not we can afford to let these firms fail. A main point from the article states that, "The federal government should slap tough new regulations on all firms that pose 'systemic risk'—the risk that a failure of one institution could wreak havoc across the entire financial system." I wholeheartedly agree with this statement and wish that the government would "step up" and implement some new security measures to prevent firms from failing in the first place.

However, once these firms are getting to a point where they are looking like they might fail, even though this really shouldn't ever happen if management teams were smarter, the government needs to keep their hands off and let the firm fail. It is not the taxpayer's responsibility to continually bail out these gigantic organizations that keep failing time and time again. Everybody in government needs to show some respect for the hardworking American's that vote them into office and not do things that benefit the few at the expense of the many.

What do you all think? Are these large firms really "too big to fail" or should we cut the cord and let them fail and see what happens?

Here is a link to the article that got me thinking about this: "Too Big To Fail": Reining In Large Financial Firms

10 comments:

LUCID FINANCIAL said...

Yes these firms are way to big to fail, but none of us can do anything about it including the government. We started down a road a long time ago that can not be corrected unless we collapse the USA economy along with the Dollar and start all over again. Everyone talks about how these institution are too big to fail, but they are so connected to each other that we need to look at it as one big sector. If the heart stops pumping the body will collapse. More regulation will not help in my opinion it will actually hurt us in the long run because that just gives more power to the government who seem to be missing the boat already. I wish I had a good solution for all of this, but I don't.

SKYLAR

Riley said...

I know it sounds a little extreme, but I think we should have let these companies fail if they are going to fail. There is a major reason that they are not making it, it's because their business models stink and they should not be in business if that's the case. All the government did was throw money at a problem that cannot be solved with money...my money, no less! The government is enabling those that perform poorly while local financial institutions, who have done no wrong, just have to ride it out and hope they make it. I also agree with Skyler, I don't think that more regulation is the answer. Whenever the government takes over something or gets their hands in it, it is almost immediately poorly run, just look and government housing. Now there's a place I want to live. Besides national security, there are not a lot of things that the government does well, so they should stay out of the financial sector as much as possible and let it run its course.

Robert said...

I can totally understand and agree with the previous comments and believe that irresponsible actions must be punished by letting the natural consequences follow. However, looking from the bail out perspective, many poor decisions made by relatively few people at the top of these major corporations are affecting the hundreds of thousands of employees and their economic livelihoods. What if the best decision, in order to minimize the severity of this economic downturn, was to bail out the major firms? What would of happened if the majority of the bailed out banks and auto manufacturers were allowed to fail? Possibly millions of people would be unemployed and a major panic could have occurred. The unfortunate truth is that we cannot see what might have been. The argument will go on forever and no one can prove their point either way.

Michael said...

i think if this big firm are going to fail then let them fail. i think the management of this big firms are responsible for their failure. By giving the money i think federal government is rewarding this irresponsible management.They should be punished for their mistake. just think if the kids do mistake and parents give them a prize for their mistake then what happen? they never learn from their mistake if they are not punished. i think we need some government regulation over this firm. Without regulation this firms are going to fail again.

Dr. Tufte said...

Thomas: since when does good management prevent failure? Failure is part of business - and it happens to both good and bad managers.

I don't really see how this post and comments relate back to the topics from the beginning of the semester: say Chapters 1-3. It's a stretch, but all I see here is poor understanding of Chapters 5-7.

Christopher said...

Dr. Tufte’s comment was quite brutal. I am offended for you...lol. Fact is, the main principle discussed in the post is clearly related to the concept of Stocks and Flows presented in Chapter 1 of the text. Let me explain.

I’ll bet that Ben Bernanke—and his Goldman Sachs cohorts—(the “Gang”), our chief managerial economists so-to-speak, never even discussed the concept of “too big to fail” when making decisions on financial bailouts. If such was the case, would the Gang really have made TARP funds available to banks of all shapes and sizes? The answer is an overwhelming, “NO!” It would have only made TARP money available to the “big” ones. Instead, TARP funds were offered to banks as large as Citi and as small as our local State Bank of Southern Utah (who declined acceptance of such for fear of the Gang’s influence on its business). Thus, if size wasn’t the issue, what was?

The real dilemma was Stock, the amount of money in the system, and Flows, the amount of money coming in and going out of the system. The Gang knew that if savers lost faith in the financial system and suddenly ran to the financial firms, big and/or small, to take their money out, that the Flows would deplete the Stock in a very short time (see Merrill Lynch, Washington Mutual, and IndiMac for proof). Because it would be impossible for savers to distinguish between healthy and unhealthy financial firms, no financial firm would be exempt. In the end, the Stocks would have been depleted at all firms, thus, making it impossible for firms to meet withdraw demands, to provide the vital capital to consumers and businesses necessary to create healthy expansion of the Stock, and to recover from unrealized losses from mortgage instruments.

Some might argue that the Gang could have printed more money to supply the financial firms in the event of a loss of faith and corresponding mass saver withdraw, but you better bet that the necessary figure in that case would have been much more than the $700 Billion TARP fund. On the other hand, I would argue that the Gang could have simply (1) increased the FDIC insurance limits to unlimited to prevent negative Flow by saver panic and (2) temporarily suspend the mark-to-market accounting rule to prevent negative Flow from unrealized mortgage instrument losses. Regardless, the Gang had to “bailout” the financial system to protect the Stock and Flows of the system. By taking no action, the Gang would have prolonged and perpetuated the disaster, collapsed the financial system, and put most of us out of work —the 2nd Great Depression.

Rebecca said...

Regulation has to be part of the solution.

As was pointed out by Sununu et al, the government is directly implicit in Fannie and Freddie. Lawmakers artificially expanded the road to home ownership. The housing market breakdown was inevitable and Washington is responsible for the sub-prime mortgage mess; all with the implicit guarantee of the full faith and credit backing of the United States.

The "who" and "how" of the regulation are the big question.

One thing is for sure, future regulators will need to be at least as skilled and versed in the law as the creators of the shadow markets that have undermined our financial strength. We cannot allow creative types to exploit gaps in regulations and create “leverage, hedge, private equity, off-balance sheet structured investment vehicle and credit default swaps” to our collective death. Socialist you say? If I pay the tab, I want the control. As Riley said, its my money!

If the United States doesn't come up with an FSOC or Risk Czar, the misguided attempts by the brain trust in Washington will surely lead us down this path again.

Dr. Tufte said...

Christopher: I think I must have had just the right level of harshness if you were able to find a connection to Chapter 1, and willing to add it to the discussion. ;)

I like your stock-flow addition. I had never thought about the bank run idea in that way.

However, I am absolutely sure that they discussed the too big to fail idea many times in formulating the TARP policy. That's a fairly standard issue that, if anything, they probably talk about too much (since it never seems to affect their ultimate decisions).

Dr. Tufte said...

Rebecca - there is research on regulation showing that it is reactive to openings created by the private sector, rather than pro-active and able to anticipate the problems that might arise. In any event, that didn't make it into Chapter 15 of our text.

Rebecca said...

Dr. Tufte said there is research indicating regulation is to be reactive rather than pro-active in addressing problems that might arise. That is a true statement and I agree that no one can ever regulate all of the possible issues that may arise.

However, the regulation proposed in the article is reactive of the problems created in the financial system(s).

Putting on my manager's hat, (in this case commenting on policy and enforcement for the good 'ol USofA), it is clear that one of the glaring deficiencies facing the US is the lack of adequate regulation and ineffective enforcement of whatever regs survived the last conservative administrations.

The issue is risk assessment. How to identify/quantify risk and how to minimize it.

I support regulation that would serve the dual purpose of making enforcement of existing laws more efficacious and providing comprehensive laws to address the now known problem areas.

My original comment touched on the skill/experience/education and overall effectiveness of government regulators. No need to repeat here.

The other side of the risk problem is addressing social policy-makers that encouraged loosening of credit standards which led to the eventual mortgage implosion.