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Issue Analysis

Too Big Not To Fail

Some pundits are saying that the big banks like JP Morgan and Bank of America are too big and need to be broken up, in sort of a preemptive antitrust enforcement. But it would be far better if we just let the free market work, as we should have been doing all along. Failure to do so will have one inevitable result: the banks will fail, because they are too big not to fail.

The Washington Post’s Kristina vanden Heuvel says it’s time to break up the banks:

Consider $2 billion lost on a bad bet, plus billions more as investors dumped the stock, a providential warning. When Jamie Dimon, the imperious head of JPMorgan Chase, revealed that the bank had lost so muchon a derivatives trade gone bad, it was clear warning that, four years after blowing up the economy, the big banks are still playing with bombs.

Now, it’s not clear that the big banks can be blamed for “blowing up the economy”, but it seems enough of a Known Fact that vanden Heuvel is able to use it axiomatically. I remember decades of being told real estate prices could never go down, watching real estate prices go down after an oil spike, and then seeing them continuing to decline. The big banks were as much a victim of the various bubbles as the rest of us.

Were we really victims?  Everyone who ever signed a mortgage first had to apply for it, and then had the chance not to sign it. And how many of us sat in the banker’s office wondering if the suit on the other side of the desk knew we were getting the best of them?

Other pundits simply call for more regulation, as if regulators looking over the shoulder of every stock trader and bank teller would fix the problem. It would not, because as yet there is no problem.

But to vanden Heuvel, the 25 billion transactions per year of derivative trades valued in the trillions of dollars is all far too risky, based on one set of such trades losing money for one bank that has the funds to absorb it easily.

IIf JP Morgan has a problem, that problem is best handled by allowing it to affect JP Morgan, not by trying to prevent JP Morgan from knowing it has a problem..

As Michael Tanner said at National Review:

There is reason to question whether more regulation would, in fact, have done anything to prevent JPMorgan’s losses. Bloomberg notes that bank regulators and the Federal Reserve already had the power to examine the books of the London branch of the investment office, where the trades in credit-derivative indexes were made. And while these investments may have lost money, and may indeed have been unduly risky, such risk hedging is crucial to making it possible for banks to lend money. Comptroller of the Currency Thomas Curry says that it is too soon to know whether the so-called Volcker Rule would have prohibited the trades in question.

In fact, attempting to regulate away losses -- whatever the size -- is the same as attempting to regulate away profit. It is a classic Fool’s Errand: impossible to achieve, and you wouldn’t want the result anyway. Tanner goes on to note that JP Morgan has already been punished for the failed trades by the market, which has devalued JPM by 10% over the deals. And that’s not including the biggest punishment: loss of faith among prospective customers and trading partners. That the punishment is far worse than JPM deserves should be clear.

I really don’t care if JP Morgan lost $2 billion on some of their trades, and neither should you -- even if you own JPM stock.  What you should care about is the high likelihood that if JP Morgan lost $20 billion that our government would bail them out -- and you should worry especially if you own their stock. It’s a perversion of the capitalist system, and one of the reasons we cannot be said to have a free market economy. But more pointedly for investors, a bailout might help a company in the short run, but in the long run it can only lead to sloth and inefficiency -- and the heavier hand of regulators who do not share your interests.

The complexity of a large organization grows with it, eventually outpacing the ability of executives -- and certainly of regulators -- to understand its operation. In time, any big organization will fail. The only question is whether we will postpone the failure with continued bailouts and punitive regulation until the organization takes us down with it.

Note: a search for the turn of phrase that is the title of this piece turned up one reference, a blog comment from 2009.

christian kowalski

no doubt-let the free market decide and get government and over bureaucracy and regulation out of the way."in time any big organization will fail" - i'm not quite sure if i understand right - but there are big organisations out there for decades and it doesn't look like they're about to fail anytime soon if ever, i.e. mercedez-benz,microsoft,exxon etc.

lheal's picture
Loren Heal

I would like to bring this idea out more. As organizations grow, they become unwieldy and bureaucratic. Big companies cannot compete for small jobs with smaller, more nimble firms, so even in markets dominated by big players you see niches served by smaller ones, for example. The big company can't make a profit serving the needs of some customers, so it leaves them to the smaller players. If the market changes so that these niches are more popular than the rest of the segment, the big company often can't change fast enough and winds up losing its former dominance, or even going out of business.

No company is permanent, and certainly not permanently on top.

The big problem with the piece is that I am arguing two different things -- that the JP Morgan derivative mistake is no big deal, and that the JP Morgan derivatives mistake is just the kind of thing that happens to big companies that leads to their demise. I thought I solved it well enough at the end, but I probably should have developed those points better.