Thursday, 28 May 2009

Too big to succeed

As I write this, Manchester United are on the verge of their champion's league final with Barcelona. I'm cheering for Barca, but I have to admit that Man U are a success. They are one of Europe's great teams, for now at least.

Let's compare them with RBS. If Man U screw up - say Ronaldo goes to Real Madrid, they overpay for Tevez who then breaks a leg, and Rooney gets even fatter and loses it - then Man U's bond holders will probably suffer. Another team - the far more worthy Liverpool for instance - will win the Championship. There will be gnashing of teeth. But the fall of this particular champion won't cause much more than a surge in beer sales as fans drown their sorrows. The problems at RBS, on the other hand, left the UK tax payer with a lot of risk, cost them a lot of money and severely restricted the supply of credit to the UK economy, with hideous economic consequences. We simply could not afford to let RBS fail.

In other words, then, some firms' size is a problem for the economy, and some aren't. (Man U's size and spending power might be a problem for football, but that is a different story.) If you have firms whose size and market position makes them effectively too big to fail, then you already have a problem. Superivising them isn't the issue: stopping them getting that big is.

John Kay takes up the next part of the story in the FT. If large, systemic providers are inevitable, or at least if we have them at the moment, we need to ensure that their functions survive their failure, whatever the cost to shareholders and the restriction on companies' freedom of action.
There should be a clear distinction in public policy between the requirement for essential activities to survive and the continued existence of particular companies engaged in their provision. There are many services we cannot do without – the electricity grid and the water supply, the transport system and the telecommunications network. These activities are every bit as necessary to our personal and business lives as the banking sector and at least as interconnected. Even a brief hiatus in their supply is intolerable.

But the need to keep the water flowing does not establish a need to keep the water company in business. We do not mind if one chain of high street shops closes its doors, because there are many other places to buy our clothes and groceries. Other industries are different. We cannot contemplate keeping aircraft circling over London while the liquidator of Heathrow Airport Ltd finds the way to his office.

In all industries where there is or might be a dominant position in the supply of essential public services, there needs to be a special resolution regime. The key requirement is that assets that are needed for the continued provision of these services can be quickly separated from the organisations engaged in their supply. The businesses involved must be required to operate in such a way that such a separation is possible.
This implies of course that there is a big difference between the big boys and the rest. The state promises to intervene in their affairs and seize their assets far sooner than it would for a less important player. If this threat is credible, not only would it be good for the economy, it also might encourage firms not to get too large. Lots of small, competitive firms are good.

Update. 2-0. Thank you Barca. The look on Ronaldo's face is priceless.



Blogger Dave said...

Effective bankruptcy arrangements allow a firm's operating assets and financial assets (and liabilities) to be separated. Non-financial assets can then continue to operate whilst financial assets are liquidated or reorganised.

This allows even quite large non-financial firms (eg Enron) to become bankrupt without interruption to essential services.

The problem with financial firms, of course, is that operating assets are also financial assets. There is no clear distinction.

So, a "special resolution" regime is required for financial-service companies, large and small, but not for other essential-service companies, however large.

A firm can only become "too big too fail" where effective bankruptcy arrangements do not exist

12:31 am  
Blogger David Murphy said...

Dave - I agree with all of that, but note that such a special resolution regime involves confiscation of assets from shareholders, and to be effective this should happen well before a bankruptcy would. I think that that is a good idea, but some bank shareholders will probably disagree...

9:16 am  
Blogger Dave said...

You mean like the FDIC does? I would love to see you post some more details and analysis of such a special resolution regime. It does seem to be the missing link in this crisis.

12:14 am  

Post a Comment

Links to this post:

Create a Link

<< Home