Tuesday, September 23, 2008

Too big to fail

Can a company get too big for us to afford to have it fail? I have no doubt people suffer when any economic entity fails. The upheaval in incomes and supply/demand paths can affect far more people than those directly employed. At some level, the suffering gets large enough and we are tempted to have our governments intervene to prevent it. What that level is varies from person to person, but I have no doubt it exists for all of us.

Is government intervention designed to prevent company failures in our markets less damaging than the consequences of not intervening? I have no doubt there are incompetent methods for intervention that do a lot of damage, but smart/experienced advisers would avoid them if they are properly motivated to give the best advice. At some level, we cannot know what the actual consequences of intervention will be due to the complexity of the markets. Even macro-economic predictions may prove difficult. However, we should be able to make some probabilistic statements if the advisers are given the time and the mandate to produce them.

If we accept the notion that no company is too big to fail, then for probabilistic reasons we should never intervene. This belief implies that the risk of harm from the intervention is worse than not acting.

If we accept the notion that some companies are too big to fail, then for probabilistic reasons we should take steps to ensure they never get that big OR we should take steps to prepare for future interventions.
  • Trust busting activities help to avoid a company getting too big to fail. Supporting these activities implies we are recognizing the risk of harm from an intervention later and preferring to intervene a little less at an earlier time.
  • Bailout activities occur at the last possible moment for an intervention. Supporting these activities implies the harm done by trust busting is worse than the increased cost of the last minute bailout.
I suspect there is no simple, definitive answer to what is best. I suspect a game theory approach would reveal some interesting details. However, so many of us are wrapped up in our pet theories for how economies work that our vision is clouded. Politics tends to make mush of our minds. I wish I knew what we should do, but I don't. I am suspicious of any who say they do.
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