Too big to succeed?

This is not really another bailout post; it’s just a short pause to notice something that we should probably think about later, when we have more time and better concentration.

I think it was Groucho Marx who said he wouldn’t belong to any club that would have him as a member. Joseph Heller used the same circular logic to comic effect in Catch-22:

There was only one catch and that was Catch-22, which specified that a concern for one’s own safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn’t, but if he was sane he had to fly them. If he flew them he was crazy and didn’t have to; but if he didn’t want to he was sane and had to. Yossarian was moved very deeply by the absolute simplicity of this clause of Catch-22 and let out a respectful whistle.

“That’s some catch, that Catch-22,” he observed.

“It’s the best there is,” Doc Daneeka agreed.

In much the same way, it seems to me there is something at least paradoxical, and perhaps self-contradictory, about spending unprecedented amounts of public money to shore up institutions so large that in better times we would rather have expected to see them get attention from antitrust authorities Now, the government not only permits mergers between gigantic banks; it demands them.

How do we explain the paradox?  The standard narrative might be that the banks really did get “too big to fail,” and that perhaps we should have kept them from getting so big but that’s water under the bridge now.  According to this narrative, our willingness to bail the banks out right now may be an indictment of our laxity in letting them grow so large, but it is not a contradiction.  The problem with this narrative, though, is that it doesn’t explain why we would choose a remedy — forced merger — that actually increases industry concentration and makes the leading banks bigger.  If they were already too big, why would we make them bigger?

I have a better explanation:  Big organizations tend toward incompetence. According to this narrative, we don’t actually need aggressive antitrust enforcement because big companies are more likely than not to do themselves in.  Businesses that face even the threat of competition don’t generally get bigger screwing their customers.  (In this, they are quite unlike many government entities, like large public school systems and of course the IRS.)  But as they get larger, they begin to suffer from poor internal communication (particularly of bad news), sclerotic decision-making, a decline in independent thinking, and a breakdown of personal responsibility.  They end up screwing their customers not because they can, but because they can’t not.

I would not go so far as to assert that all social units larger than Dunbar’s number are unstable. But whenever I read of the collapse of large and storied institutions like Arthur Andersen or Heller Ehrman, the sociology of the place usually seems like the likeliest cause.  And perhaps, when the story of the current financial crisis is written from a safe distance, people will think that one important reason the five major investment banks all failed was because there were only five major investment banks.

Steven Pearlstein, writing in today’s Washington Post, highlights a small regional bank (Citizens South) that didn’t actually need any TARP money, but took some anyway and then came up with a creative way to use it to clear out shaky loans on distressed real estate.  Pearlstein notes that the CEO of that bank made “only” $456,000 last year, and concludes:

And get this: Somehow the directors of Citizens South managed to attract and retain a chief executive who turned in respectable profits during good times and bad, and yet was able to pay him only 10 times the salary of the average employee. Pretty neat, huh?

So here’s a question the House Financial Services Committee might put to the Titans of Finance: How is it that Kim Price, a community banker with an undergraduate degree from Appalachian State University, a tiny executive staff and a pay package that you would consider insulting, somehow managed to come up with a more creative use for his government bailout money than any of you?

To Pearlstein’s rhetorical question, I would like to suggest this answer:  It’s because a large number of small businesses is bound to outperform a small number of large ones.

We might have taken a different course in October.  Large banks with too many toxic assets might have been declared insolvent; their assets might have been purchased by a number of different regional banks with healthier balance sheets, and the blue chip companies who all of a sudden had no credit with the major commercial banks could have switched their business to the upstarts. Ditto with the law firms and other businesses farther down (or is it up?) the food chain.  As with banks, there are natural forces that push us along toward recovery.

But instead, we made everything bigger, from the government dishing out the money to the banks lining up to take it.  Maybe the folks in Treasury and the folks in the Antitrust Division of DOJ should sit down together and figure out what they really think about market concentration.

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6 Responses to “Too big to succeed?”

  1. Timothy Peach Says:

    I can tell you based on first-hand experience that in financial services, size and incompetence are highly correlated.

    Consolidation past a point is about creating a massive wealth base for the oligarchy and NOT about synergies and opportunities.

    You have to have a Herculean CEO (e.g. Jamie Dimon) to make one of these monstrosities work. That’s because Jamie runs JP Morgan like a small business — he takes responsibility for everything, and his word is law. At the other messes, what you end up with is a broken cluster of massive fiefdoms that don’t talk to each other. Internal inward-facing bureaucracies clog every process and make it impossible to innovate, transact nimbly, or manage any risk real-time. And there is no sense of “the firm” — everyone just fights for their piece of the sloppy pie, and the whole thing becomes ugly and rudderless.

    There is a sweet spot in terms of efficiencies that come with size vs. inefficiencies that come with the idiosyncrasies of human nature and crowd behavior. It’s probably something like a fifth to a tenth of the size of our biggest banks.

    The important things to remember are that people, if given the opportunity to be awful, will be, and that I hate everybody.

  2. Mark Esswein Says:

    Perhaps massive layoffs to complete a merger are the red flag that whole point is to benefit the oligarchy.

    I have a theory that as companies grow larger, the margin that they seek grows smaller. So small in fact, that they eventually lose interest in creative long term goals.

  3. Mark Esswein Says:

    OK, now I’m PO’d. GM, who wheedled a bailout deal now says give us more or give backing in bankruptcy. Screw ’em! Deal with the judge!

    I thought at the beginning that the automakers should have gone for the structured bankruptcy, but no, can’t do that, who’s going to buy cars from a company in bankruptcy. Now they have to deal with the problem of who’s going to buy cars from a company that is likely to disappear.

  4. Timothy Peach Says:

    Dems in bed with the unions, dude. No way they’re going to kill the host. Do you have any idea what a GM bankruptcy (of necessity followed by a Ford and Chrysler bankruptcy, or necessity followed by the bankruptcy of all the Tier I suppliers) does to the UAW? It’s a death blow.

    Get ready to cough an endless stream of tax dollars into them.

  5. George Peacock Says:

    Add zombie car makers to the zombie banks. It’s like we don’t even read the history books. More later on “too big…”

  6. Mark Esswein Says:

    The rescue will occur when people start thinking outside the box. I’ve been a fan of Tom Friedman for quite some time; I think this column pretty much nails it with regard to the current situation…

    http://www.nytimes.com/2009/02/22/opinion/22friedman.html?em


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