Nothing is too big to fail
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As you read this week’s column I’ll be preparing to land on St Bartolome Island in the Galapagos. Soon I’ll be snorkelling among the penguins and later I’ll be heading further along the coast to be among sea lions and marine iguanas.
It’s a world far removed from that of banks and building societies and regulatory authorities but it is the place where Charles Darwin first began to question the idea of the creation and form his theory of natural selection.
So I’m reminded about how people back home have been debating the future of some of the banks as if they were dinosaurs and have punned about the massive bonuses that are still being paid to executives from some of the bailed out institutions, calling the practice ‘survival of the fattest’.
This year, of course, marks the 150th anniversary of the publication of the Origins of theSpeciesand I suppose it isn’t surprising that people might think of the crisis in the financial world in evolutionary terms, hence allusion to dinosaurs and the rest.
On the other hand, evolutionary theories have pre-occupied economists for a long time now. For example, the Austrian economist Joseph Schumpeter formulated the theory of creative destruction in which new entrants into a market created long-term economic growth, even if they destroy the value of old and successful companies.
A contemporary British economist, Paul Ormerod, draws on Schumpeter’s ideas in a book called Why Most Things Fail. This has the subtitle Evolution, Extinction and Economics and in it he argues that there is a precise mathematical relationship which describes the link between the frequency and size of the extinction of companies and that this “is virtually identical to that which describes the extinction of biological species in the fossil record”. The only difference, he concedes, is in the timescale.
Ormerod’s book was published in 2005, too early to offer an insight into the current crises but if his ‘iron law of failure’ is that unbending, it’ll be interesting to see which institutions it will strike next.
The notion that some financial institutions are too big to fail certainly flies in the face of experience but it is the fear of the consequences of failure that is the real issue that drives the political classes to bail out the dodgy bankers and that needs to be addressed.
To that end Mervyn King, governor of the Bank of England, has said that some of the banks must be broken up to protect the economy from future financial disasters and that dividing the institutions core businesses from their riskier practices would help to ensure that they were not too big to fail. But Prime Minister Brown has slammed that idea, so come 1 December I’ll be returning from the land of iguanas to the land of the financial and political dinosaurs where, for the moment, extinction has been put on hold and only the European Commission has a handle on down scaling the monopolies created by the state.
