Monday, October 26, 2009

"Too big to fail" failure

The New York Times reported today that Congress is trying to "rein in" companies that are "too big to fail." When I saw the headline, my first thought was, "It's about time." My second was, "I wonder if they've been following my blog rantings." Unfortunately not.

According to the NYT, the plan is as follows:

The measure would make it easier for the government to seize control of troubled financial institutions, throw out management, wipe out the shareholders and change the terms of existing loans held by the institution.

In the event that a crisis were to occur, the proposed bill sets up corporate living wills:

It would force such institutions to hold more money in reserve and make it harder for them to borrow too heavily against their assets.

If companies of this magnitude continue to exists, I feel like these steps are good measures to protect the financial system as a whole. But that begs the question, why do we let companies of this magnitude exist? I think it's time for some good ol' Roosevelt trust busting.

I don't want it to be easy for the government to step in and start running a business; that's not how a capitalist system should work, and under that model it can't. Organizations take chances with each decision they make, some leading to greatness and others to failure. Eliminating risky business ventures can slow the failure rate, but it seems to me that it would also slow invention.

Also, the idea of not borrowing too heavily against one's assets is really just common sense. However, even Adam Smith new the value of credit, and he always argued that you would be foolish not to have all of your assets working to turn a profit. Wealth is created by making your money work for you, not by you working for money.

And that's really the principle behind investing, especially in potentially high-yielding ventures like many in the stock market. Speaking of the stock market, it employs this really great method of limiting centralized power and generating wealth: splitting stocks.

Companies' boards of directors typically elect to do 2-for-1 stock splits, meaning they double the number of shares and halve the price of each. This makes stocks not only more numerous, but also more affordable, which encourages additional investing by an increased number of shareholders. This helps to generate capital for institutions and it expands the ownership power base, thus limiting it. Not to mention the fact that stocks often increase in value after a split, so it generates more wealth for shareholders as well.

The same could be done with any company that is "too big to fail." Split them into smaller companies, diversify the power base within that field, and let them compete, grow, or fail as performance dictates.

The problem is less the behavior of these companies than it is the "too big to fail" part, so let's just eliminate that and be done with it.

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