Comment on ‘Bigger is Not Always Bad’ (NYT Room for Debate 12/08/2010)
In response to:
New York Times | December 8, 2010
Where to start! This is a horrible piece of rhetoric…it doesn’t even qualify as a serious analysis of the problem. I would hope that Professor Rajan has higher standards for his students than is reflected in this painfully transparent apology for an industry gone terribly wrong.
Let’s take the glaring flaws in order:
1. The 4th paragraph is built around a patently specious, self-abnegating straw-man scenario in which the author imagines a very specific, unsavory route to “too big to fail”, as though that’s the only – or even a likely – way that firms scale. Setting aside the fact that the premise (“senseless mergers”) flies in the face of any concept of good corporate governance, the structure of the argument is one that wouldn’t get past a freshman philosophy major, yet alone her professor. Saying that something is bad because it’s senseless is circular hogwash.
That, however, is not the worst of it; by focusing the reader on this narrow, highly-unlikely route to corporate obesity Prof. Ragan trivializes the problem. This is an illegitimate cul-de-sac in the discussion, and seemingly only there to confuse the subject.
2. In the following paragraph, Prof. Rajan starts off with the word “finally”, suggesting that somehow all of the ground in the argument against ‘too big to fail’ has been covered. Nothing could be further from the truth. This may seem a trivial criticism, but it is an all-too-common ploy to try to manipulate the mind of the reader, and so deserves to be called out. It’s just wrong to tell people you’ve covered a topic when you’ve barely scratched the surface.
3. The next paragraph is particularly insidious because it seems to attempt to address the flaws pointed out in #1 above, when in fact it does no such thing. As with the critique in #2 above, this is rhetorical legerdemain, pure and simple. But again, it gets worse: the claim that “it is the successful firms that grow faster in a competitive environment” is both circular (because success and fast growth are often taken to be the same thing) and inaccurate (because, as we’ve seen, high-fliers all-too-often end up crashing – so today’s “success” may end up being tomorrow’s disaster. In fact, there is plenty of recent evidence of a direct correlation between fast growth and ultimate failure: Madoff, Countrywide Mortgage, Enron…and, sub-prime mortgages & of course, the Country of Ireland). For a finance professor to treat such a discredited canard as a given is unforgiveable.
4. There is little evidence that “large firms have the resources to attract better talent and to build better organizational structures.” There is however, plenty of evidence, that large firms – and banks, in particular – can use the lure of asset bubble-driven trading gains to significantly distort the market for professional talent, siphoning off otherwise-useful high-potential graduates into economically counter-productive pursuits. This is an evil unto itself – not only is society robbed of people who might actually do something socially and economically useful, it creates a feedback loop of groupthink and entitlement. What’s the point of educating a kid at a top-flight school only to have her head to Wall Street to dream up increasingly complex schemes to manipulate securities markets? China loves it, or course…asset bubble-driven consumption does lovely things for their balance of trade account….
5. There’s very little evidence to support the claim that “small and medium-sized banks have not shown better judgment than the riskiest large ones.” Not only is the obvious rebuttal – once again! – contained in the sentence (bad judgment at a riskier bank is more damaging than bad judgment at a less-risky one. Duh!), smaller banks are inherently more constrained by the rational risk mitigation strategies of their counterparties than are large ones. Why? (drum roll please…) Because THEY’RE NOT TOO BIG TO FAIL! They have to operate in a much more efficient marketplace than do large ones because – as Professor Rajan says himself at the outset of his “case” – they’re not implicitly backed by the US government. It’s charlatanism to even suggest that a small bank can do as much damage as a large one, or that there’s any sort of demonstrated marketplace dynamic in which a group of small banks can combine to pose as much risk as a single entity that has the same footprint. I’m sorry, but this kind of thing is just enraging to serious thinkers!
6. The next detour on the hard-to-swallow romp through Professor Rajan’s fantastical landscape of distorted financial theory is the notion that the current systemic risk has anything to do with regulating future bank mergers. The problem is the current crop of behemoths, not some future imaginary spate of industry-consolidation (which, as an aside, is virtually impossible – the level of concentration today makes it virtually impossible to create another such Frankenstein).
Given how horribly Professor Rajan describes our banking systems’ current problems and how we got here, it hardly makes sense to pay much attention to his proposed solutions. But it does make sense to say that even if his analysis were correct (which it decidedly isn’t!), his prescriptions for dealing with systemic risk are so weak as to seem little more than sandbagging. Complex capital structures, highly-subjective contingent regulatory responses to crisis situations, and (what is he thinking?!??) doing away with deposit insurance for “large well-diversified banks”* are all the province of THC-addled academics. His claim that this strange brew would somehow “reduce complexity” is laughable – fuzzy lines are what started the misery in the first place!
Even with all of the above, the biggest flaw in Professor Rajan’s analysis is what it ignores: the fact that the large banks taken form a de-facto oligarchic industry structure, and that they use the classic tactics of highly-concentrated industries (signaling, competition-avoidance, unified lobbying efforts, regulatory capture) to generate illegitimate economic rents. All of which is saying that by being ‘too big to fail’ they also (conveniently) cook the market.
Lastly, the systemic risk posed by the highly-concentrated structure of the banking industry is only the most prominent problem. The less visible, but far more damaging, one to our economy is that such concentration distorts the market to the gross disadvantage of everybody who does business with a bank (which is to say, everybody). You don’t have to look much further than Goldman Sachs’ execrable abuses of its own clients to get a flavor of this, but it’s important to bear in mind that the difference between GS and it’s “competitors” is degree, not kind. To espouse anything else is to be willfully ignorant.
I find it shocking and horrifying that anybody with claims to academic credibility would attempt to put forward such a demonstrably misleading position. I know that the ‘Chicago School’ functions as the Vatican of free-market fetishism, but even Pope Benedict has acknowledged that where fatal diseases are involved, prophylaxis trumps dogma. Would that Professor Rajan would follow his lead.
* Who decides the threshold for revoking deposit insurance? How do we know that the dependence on deposit insurance didn’t foster lending practices which would be unsustainable if it were suddenly revoked because that magic line had been crossed? Wouldn’t clever lawyers figure out ways to create groups of affiliated legal entities so that a holding company could get huge while its subsidiaries all stayed just beneath the threshold?