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Saturday, February 6, 2010

Response to Comment: The Fallacy of Too Big To Fail"

NEPArtisan was kind enough to comment on my posting on "Too Big To Fail", so I thought I'd add a few thoughts in reply via a separate posting.

Before I write anything else, I want to thank specifically Tom & generally anyone who stops by to read this stuff. I don't write this to entertain, amuse, enlighten or enrage anyone except me; to the extent that anyone reads this stuff and find it interesting, well that's probably more of a compliment than I actually deserve.

So on to the posting. I'm letting Tom's comments stand as-is, with my responses noted in dark red italic text.

The "too big to fail" moniker may be a political buzz term, but it isn't undeserved.

Your argument that irresponsibility is the problem is indeed accurate, but when banks become mega in size and scope, the likelihood of fraud sets in.

I disagree with the premise. There are plenty of smaller businesses in general and banks specifically that engage in fraud all the time. The fact they don't make the news (be in "regular" or business) is simply a function of media/public interest, and I've never read a credible piece of evidence that shows a correlation between size and propensity for graft/fraud/wrong-doing. You could argue that larger organizations are sufficiently complex that it's easier to disguise fraud, but I could then argue that smaller organizations are less scrutinized, so what they lack in complexity is made up in anonymity.

The size of a company is directly relative to the damage it could do if fraud is perpetrated.

Yes, but I could substitute the word "company" for any "organization" and the same would be true. In other words, your point is not unique to for-profit companies in general or the financial services industry specifically. See my reference to Microsoft, below.

In a capitalistic system, greed is an oft-rewarded virtue and taking advantage of either lax regulation or confusing financial products, etc. is further enabled by size. Obfuscation and purchasing power (i.e. lobbying, lawyers, etc.) grow with company size as well.

GREED - Well first, greed is not a virtue, it's technically a vice. It's easy to get caught up in the Bernie Madoff's and AIG's of this world, and for sure every organization has it's share of greed-heads and villains. Note the word "organization". I could argue that greed was the driver of one of the worst judicial scandals in US history, right in our backyard (with judges Chiav & Conn); was that greed perpetuated as a result of organizational size? No, it wasn't the court that was greedy, it was the judges.

FINANCIAL PRODUCT COMPLEXITY - In my opinion three things drive the complexity of financial products in the US:

1 - The sorry state of the US Tax Code.
Want to know why many products are overly complex? Honestly...and I say this as someone who is fairly progressive when it comes to social's because successive Presidents and Congresses (both Republican and Democratic) have use the Tax Code as a tool for social engineering. If you want to use the power of taxation to create change, then one of the by-products is going to be an incredibly complex tax code. This, in turn, makes financial products much more complex, as they must live within the system. It also creates a cottage industry in the "how to pay less in taxes" business, which both individuals and corporations take advantage of all the time.

2. Litigation.
Right or not, many financial institutions feel compelled to create incredibly complex products & documentation in order to satisfy any and every potential legal challenge. Lawyers in Congress write laws so that only lawyers outside of government can interpret them so that litigation attorneys can take advantage of them when someone might be harmed in some fashion.

3. Society is Complex
Finally, we simply live in a complex society. For example...we all want to be able to download MP3s from the Internet, but yet how many of us actually understand the process by which that music is made available & how the artists, music companies, distributors, etc all make money? That's just one example in a small pocket of our society; multiply it by 1000 if you want to get into the guts of how money flows in this country. Maybe the Amish have it right, but the reality is that we have collectively created in incredibly complex society.

SCALE OBFUSCATION, etc. - Yes, scale can create opportunities for graft, but it doesn't create that graft. It's also not unique to corporations. For example, it's fair to say that there is graft and wrong-doing in the Department of Defense, but yet is Congressman Kanjorski claiming that it should be broken up, lest it fail and throw the country into disarray?

When these companies engage in fraud (only two people have been charged in the crisis, and both were acquitted by the way) the impact is exacerbated by their market share.

Would the same argument be made if Microsoft were found to have perpetuated an act of fraud? Talk about too big to fail! According to, Microsoft is used as the operating system on something like 92% of the world's computers. The potential failure of Microsoft could be catastrophic (for example, MS produces a virus patch a month for it's operating systems...if it were gone, that would disappear, exposing millions of computers to hackers and viruses), but yet "too big to fail" is being applied as a remedy to companies in the financial services sector. Now why would that be?


Here's why: because right now it's SEXY to beat on the financial services industry. They are today's boogie-men, just like some other industry was 5 years ago. What's more, Congressman Kanjorski is guilty of at least being disingenuous, as he has received more than his share of money from this same industry he is demonizing.

Hence, "Too big to fail". Sure, you could say something like "So big that systemic corruption causes financial meltdown" but the former label sounds better.

It's isn't "big" or "corporations" that create greed and graft, it's people.

I've worked in the financial services industry for 21 years, and for most of that time I've had a Pennsylvania Insurance License & Securities Industry registrations. I've seen a lot over these years, from people that were/are some of the brightest human beings on the planet to others who should be selling used cars in Nannicoke for a living. What I haven't seen is a systemic pattern of evil behavior perpetuated because companies happen to be large. That's one of the reasons why "too big to fail" bothers me.

Another reason? I work for a large financial services company that did not receive TARP money, one that has not engaged in systemically fraudulently behavior, one that has managed assets in a conservative manner for more than 125 years. Yet, my employer...simply by virtue of it's size...could end up being negatively impacted by "too big to fail" legislation. Why? Because it is big.

Tom, I agree that there is fraud in the financial services industry, but I don't agree that organizational size is a cause. That kind of logic seems (as I've noted before) designed to be a smoke-screen to hide the real issue: a history of regulatory failure in the industry. Think about it: Is it logical to potentially punish companies like Met Life and Prudential because of the failings of companies like AIG and The Hartford (for example)? That would be like the US government punished every person of Saudi Arabian decent for the actions of the 911 terrorists.

A final example: probably the worst example of industry fraud was perpetuated by Bernie Madoff, a man who founded a firm that was actually fairly small in overall size relative to this industry. Yet Madoff literally "made off" with enormous sums of money. What failed there? In my opinion Madoff symbolized the real issue: namely that many segments of the industry are largely self-regulated.

What really should be done? Congressman Kanjorski and others who advocate for "Too Big To Fail" legislation should, in my opinion, spend their energies to craft a regulatory structure that is more independent and rigorous. Let's stop letting the industry largely police itself. That will most likely not happen for a variety of reasons, including the fact that discussions about SRO's (Self Regulatory Organizations) don't make for very good sound bytes...hell, I don't think that the public at large even knows that this industry largely polices itself.

1 comment:

Tom Borthwick said...


Thanks for replying. It's nice to have rational discussions! So rare in politics.

Small businesses may certainly engage in fraud, but the impact is limited. If a mom & pop shop has runs poker in the back room, sure, they're doing something illegal, but that's not going to bring down the economy.

You are quite right about graft at the Defense Department. That needs to be reigned in, but the argument "well, they're doing it, too" doesn't implicitly mean that focusing on one industry is wrong. I think we need to stop graft and fraud everywhere, but if the financial indsutry is being focused on now, so be it. It's a step in the right direction.

I know that greed is a vice, and it's what's inherently wrong with capitalism. In a capitalistic system, it is a virtue. I wouldn't argue that greed is limited to corporations. It's systemically encouraged. Ever read a sixth grade civics text book?

I agree with your three causal issues. Regulation is the only way to handle this issue, but, again, company size makes lobbying against regulation easier, does it not? And after Citizens United, corporations will be able to make law even more favorable than it is now and keep regulation as lax as it is now. Size matters and is a direct correlative to influence and economic impact.

As for litigation, that's sad that they feel the need to obfuscate to protect themselves, and I think that's weak anyway. It's wrong if they do that, sure. I don't think law is structured to make it easy to win big money. And the implication here, tort reform, is just a scapegoat. The amount of money these companies pay out is comparitively little (look at the $$ effects of malpractice vs, say, the amount of money spent on pharma ads). Their ability to take advantage of laws to delay litigation or totally derail it is epic in scope. Look at Monsanto and the Midwestern Farmers they routinely bankrupt. Somebody very close to me requires two years before they can get to court to get an insurance settlement for a permanent injury sustained in a car accident. This is wrong. This is enabled by the massive funds available by the company to fight anything that might be fiscally detrimental.

But I'm not directly addressing your overall argument. You're premise is basically that the root of corrpution is an individual, not a corporation or entity (amusing but irrellevant point, corporations are people, too!). I agree.

But I'm not sure how you can argue that the scale and effect of corruption is solely on the head of the individual. Is the problem not enabled by both the system and the size of "organizations." Is it not exacerbated by size? Corruption in Mom & Pop shops will not cause financial meltdown.

On an ancillary note, I believe "corporations" should be the label, rather than "organizations" because corporations, rather than the government that you single out as an organizational example, because the profit-motive separates the two. The DoD money-wasting goes where? Defense Corporations.

Back to your main argument, though. Size does matter. If I have a megaphone, as opposed to cupping my hands, my sound will be amplified more. Just like the fiscal impact will be amplified.

I think, maybe, for you it comes down to individual accountability, but when the system rewards greed and encourages it from childhood, just regulating business won't make this go away. You can't change the culture with regulation. But you can prevent widespread economic damage by granting the government the power to break up financial companies that are "too big to fail" i.e. so big that the corruption and greed of individuals therein can cause meltdown.