Too big to fail?

After a financial crisis, it’s very interesting to know what CEOs of financial firms think of the financial system, how do they address the problems. Letters to shareholders provide a reasonably good way to know its management, its principles and the way company is run. Recent letter to shareholders from JP Morgan chief Jamie Dimon gives a good way to know more about this man. I believe he rates ethical behavior above anything else. Apart from his stellar performance at BankOne and JP Morgan his ethical behavior makes him stand apart from the crowd. It is a good letter to read after Warren Buffett’s letter last month.

To address the problems of financial crisis, government has taken many steps to prevent the future crisis. Government has done a remarkable job without which the situation could have only been worse. Among many possible measures one significant issue discussed is scaling down the size of the banks. In his letter to investors, Jamie defends the size of the banks. I believe cutting down the size will not address the issue but definitely pose new threats to the economy.

I believe the argument that ‘too big is bad’ is fallacious. It emerged mainly due to bail out of AIG because it was thought the whole system will collapse if it was not bailed out. It is true that the situation would have been devastating and unimaginable if it were not bailed out. But is it the size that brought the world to this crisis? I doubt this. It is the reckless risk taking, excessive reliance on the mathematical models and not applying the common sense (which is uncommon) caused this. So by downsizing we are definitely not shooting at the target.

What would be the consequences of the scaling down the banks? Many companies are opening the shops in the emerging markets. Consider the markets of China, India and other developing countries. It would require massive amount of investments for companies to seize the opportunities in these countries. What would happen if Apple had to go to 10 different banks to raise the investment? It will only delay the time required to raise the investments. It would be cumbersome to deal with these many bankers and again finding bankers for other needs like risk management. It would increase the bureaucracy and seriously affect the productivity of these companies.

The worrying factor though is that the foreign banks will be out of purview of the downsizing. Obiviously the companies would go to foreign banks for investments needs. The economic system is so much interconnected that a failure of one bank would cause a serious trouble to the whole economy. Even if we assume that big is bad, and then suppose a foreign bank does what AIG did, it will bring the whole system again to the to its knees. So the whole point of downsizing seems illogical. It reminds me of a time which I read in the autobiography of Lee Iacoca. There was a time when Japanese economy was closed but America’s was open. It made Japanese automobile companies to intrude American market but denied American companies the entry in Japanese one. What it did was that Japanese companies shared the large chunk of the automobile market and Americans lagged. American automobile manufacturers still struggle to gain the top spot. Will this be the case if we downsize the banks? Probably. The hard work done to gain the epic center of the financial world would go in vain.

So what would be the solutions? We need to make sure that the men at the top act responsibly. The culprits still go free with millions for their retirements. They should be punished and the strong signal should be sent that they wouldn’t be let go if they create the mess. Let me end by what Jamie said in his letter- “Bad outcomes are not always someone else’s fault—we need to cultivate an environment where consumers, lenders, borrowers, businesses and investors all take responsibility for their actions and don’t look for someone else to blame.”