From Antitrust to Anti-Systemic Risk
posted by Frank Pasquale
The “optimal size and complexity of developing countries’ financial systems” has been hotly debated in the economics community. Writing for the Harvard Business Review & Boston Globe, Duncan Watts focuses on our own dilemmas in a provocative account of complex systems:
[G]lobally interconnected and integrated financial networks just may be too complex to prevent crises like the current one from reoccurring. . . . A 2006 report co-sponsored by the Federal Reserve Bank of New York and the National Academy of Sciences concluded that even defining systemic risk was beyond the scope of any existing economic theory. Actually managing such a thing would be harder still, if only because the number of contingencies that a systemic risk model must anticipate grows exponentially with the connectivity of the system.
So if the complexity of our financial systems exceeds that of even the most sophisticated risk models, how can government regulators hope to manage the problem? There is no simple solution, but one approach is close to what the government already does when it decides that some institutions are “too big to fail,” and therefore must be saved – a strategy that, as we have seen recently, can cost hundreds of billions of taxpayer dollars. . . .
An alternate approach is to deal with the problem before crises emerge. On a routine basis, regulators could review the largest and most connected firms in each industry, and ask themselves essentially the same question that crisis situations already force them to answer: “Would the sudden failure of this company generate intolerable knock-on effects for the wider economy?” If the answer is “yes,” the firm could be required to downsize, or shed business lines in an orderly manner until regulators are satisfied that it no longer poses a serious systemic risk. Correspondingly, proposed mergers and acquisitions could be reviewed for their potential to create an entity that could not then be permitted to fail.
Of course, our system has been headed in precisely the opposite direction, largely thanks to the “best and brightest” now at Treasury and the Fed. As Simon Johnson puts it, we “pay too much deference to the expertise and presumed wisdom of a sector that screwed up massively.”
July 20, 2009 at 8:57 am
Posted in: Antitrust, Corporate Finance, Economic Analysis of Law
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Responses (2)
A.W. - July 20, 2009 at 2:22 pm
I’m not a fan of Ron Paul, but he said one thing that was smart, in a sort of “broken clock is right two times a day” sense. “If you subsidize something, you get more of it.”
So if you subsidize risky behavior, you get more of it.
The answer isn’t to say anything is too big to fall, but to let it fall. then let everyone understand that they need to watch every investment, to understand that anything can collapse. Then the people will price the risk more realistically.
TRUTH ON THE MARKET » Too Big To Fail as an Antitrust Concept - September 17, 2009 at 12:06 pm
[...] failure would cause substantial damage throughout the economy. The idea might be catching on. Frank Pasquale recently cited to Johnson’s work favorably. The idea has also been favorably cited by [...]
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