2008 December 06 Saturday
Financial Consolidation Causes Bigger Financial Disasters?

What caused the world economic crisis? Kurt Cobb points to an argument that fewer and bigger financial companies make for fewer and bigger financial mistakes.

For former Wall Street hedge fund manager and self-styled student of uncertainty Nassim Nicholas Taleb an important cause of the current financial meltdown is best described by ecological science. The system has become overoptimized. The consolidation of finance into the hands of fewer and fewer large players--banks, insurance companies, investment banks, and giant hedge funds--has made it less vulnerable to frequent crises, but more likely to produce a severe crisis when there is a breakdown in the system.

What used to be country-specific or regional crises, now become worldwide crises. In the past we've had the Mexican crisis, the Asian crisis, the Argentinian meltdown and most recently the utterly devastating hyperinflation in Zimbabwe. But none of these became global crises.

"It's vastly more optimal to have one large bank than 10 small banks. It's more efficient," Taleb told The News Hour with Jim Lehrer recently. "[But,] when one bank, [a] large bank makes a mistake, OK, it's 10 times worse than a small bank making a mistake." The moral of the story: A world with a lot of small banks is far more resilient than one with a few large banks. That's the kind of result one would expect in biological communities, and it turns out to be true, not surprisingly, in human communities as well.

Not sure I buy this argument. The Savings and Loan crisis of the late 1970s and 1980s featured a large number of S&Ls all making the same mistake.

But globalization does bring more economies into sync with each other and has caused the financial mistakes that led to our current financial crisis to occur on a global scale rather than just a national scale.

Share |      By Randall Parker at 2008 December 06 05:05 PM  Economics Disasters


Comments
Thai said at December 6, 2008 5:57 PM:

This is completely true (unless you want to argue with the law of the conservation of energy). It is called the conservation of risk and it is a fundamental of the system we live in. You cannot eliminate risk within a system- you can push it from one system to another but within a constrained system risk remains constant, it is a fundamental law of science. We can choose to have lots of little blow ups or one big one but centralization does not reduce out risk at all.

dchamil said at December 7, 2008 6:24 AM:

A bank too big to fail is a bank that needs to shrink.

Thai said at December 7, 2008 9:28 AM:

Amen


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