Thursday, March 18, 2010

How Big is Too Big?

Senator Chris Dodd has a plan to give the Federal Reserve the power to split large firms into smaller pieces. The rationale here is that during the current financial crisis, we witnessed large firms ready to go belly up and take the economy down too. The assumptions here are that large firms can bring down the economy and by splitting them into parts when they get too big, we can save the economy.

I have a few questions:

1. In the normal course of events in the marketplace, companies are aggregated and companies are broken apart. The metric for these decisions is profit and loss. If there is value to be created by merging companies, they will be merged. If there is value to be unleashed by splitting a company in two, that company will be split in two. There are individuals who put their time and money on the line to make the right decision. In the case of the Federal Reserve, how will it determine when companies are too big and does the Federal Reserve face the same incentives as companies in the marketplace to make the right decision?

2. There are many large companies in the world, not just in the financial industry. The laws of economics are obviously not suspended for this one specific industry. Why do we not concern ourselves when a large non-financial company is about to go under (and being content with the knowledge that its assets will be sold off to others who will use them more productively), but we begin envisioning The End Times when a financial firm is about to go under (as if there is this gigantic piece of wealth, encompassed by the financial firm, that is about to just vanish, taking everything and everyone down with it and leaving nothing in its tracks for the rest of the world to survive on)?