The Bankwatch

Tracking the consumer evolution of financial services

Systemic Risk | Was Lehman Brothers too big to exist?

Here is a blog concept from Harvard Business that might be interesting to you.  The idea is to focus on summarising new evolving big picture themes for business people.

Behind the breaking business news is often a management idea gone right or wrong. That’s where the Conversation Starter comes in. With this blog, we hope to shed new light on major events and trends in the business world by helping unearth the bigger ideas at work and discussing how those ideas are shaping our lives every day. We hope you’ll join the conversation.

This one caught my attention.  It speaks about the difficulty in identifying systemic risk – risk of the entire system collapsing.

Too Big to Fail? How About Too Big to Exist? | Harvard Business Conversation Starter

If yes, the firm could be required to downsize or shed business lines until regulators are satisfied that its failure would no longer pose a risk to the whole system. Correspondingly, proposed mergers and acquisitions could be reviewed for their potential to create an entity that would then be too big to fail.

CitiBank, Lehman Brothers, Bank of America.  One of the three went down, and arguably brought the world system to its knees.  What if others went down?

The blog poses the right question.  “What would happen if X went down?”  This is a better question than “what is the likelihood of X going down”.  The latter question will always be answered based on knowledge of the status quo, and invariably answered with ‘no likelihood of going down’.

But if we ask “What would happen if X went down?” we are forced to look into the window of the impossible and consider implications too serious to otherwise contemplate.

The blog speaks about a power outage in Western US as an example.  A more recent example was the 2003 outage in NE North America when one part of the power grid in Ohio went down, and within seconds 50 million people had no power for 36 – 72+ hours.  The blog makes the point that power grids and financial systems are the same.

These are unusual times we live in, and we need different and better ways of assessing risk.  Some say we are evolving to a market economy, that is more based on pragmatism, and opportunity, that will build on the older traits of welfare and security, and offer better results.

Relevance to Bankwatch:

Maybe in the next economy, being too big or too tightly integrated is a flaw that the market economy cannot contemplate or allow. If the market economy is about opportunism and offerring the best environment for people to succeed, then one might ask why we would allow a member of the financial system to become so large as to represent a significant risk to its continuance.

“No more business as usual” is easy to say, but what difficult decisions does that entail?

Written by Colin Henderson

February 23, 2009 at 23:36

4 Responses

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  1. Where we get into trouble is when we start mis-defining the problem. Size had nothing to do with this mess. Over-leveraging, risk-taking, overly complex investments, irrational prospecting, and questionable oversight had much more to do with the financial meltdown than the size of any bank, be it investment bank or retail bank. “Too big to fail” was a judgement made by the exact same people who allowed this credit crisis to take shape. In actuality, I believe our solutions have become the crisis…much more so than simply letting the free market punish failure and reward success.

    Don’t punish growth…just make sure that said growth isn’t an artificial by-product of unbridled risk-taking. That’s where we failed. Limiting an organization’s ability to grow is the wrong solution to the wrong problem. Instead, limit how leveraged a company can become. Make sure ratings agencies know what they’re doing before they can issue a judgement on any investment. Make sure that our monetary policies are rational.

    Credit Union Warrior

    February 24, 2009 at 08:49

  2. Size matters if it is true that what can go wrong will go wrong (regardless of all too human attempts to “regulate”), and the financial industry is so concentrated that there is no viable option except a taxpayer bailout. I wish economists would start investigating the constraints of size instead of simply touting the doctrine of “bigger is better”. The antitrust laws were enacted in the late 1800’s on evidence that too much concentration is harmful to competition. I submit that we have evidence now that financial concentration creates excessive and unnecessary systemic risk.

    Broox Peterson

    February 24, 2009 at 10:19

  3. I understand the sentiments expressed, but i have one question – define risk taking? Define the estimate of risk that society will accept in a company before the impact of that company is such that society is affected?

    I am as (more) capitalists that anyone, but I see a potential here that capitalists even don’t understand.



    February 24, 2009 at 20:34

  4. […] is not necessarily feasible or acceptable to have them taken over by each other.  We get into the too big to exist problem that could forsee further crises in the future.  There are 19 banks undergoing stress […]

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