Friday, November 28, 2008

Financial Size Regulation

In my article on the establishment of a universal health care system, I emphasized the importance of distributing oversight and management down to the State level. Upon reflection, I realized that this must be also done for a number of quasi government agencies directed to implement national policies.

The most visible today are Fanny Mae and Freddy Mac. They are, as national instruments, far to big to fail. As State instruments, they could and be swiftly reconstituted as viable enterprises. And the temptation to deploy resources into the international securities market both as a buyer and seller abates. Do you really think that this could have happened had that been implemented in the first place?

Surely AIG deserves the same fate for the same reasons. Besides, the underwriters are past masters at syndicating the larger deals needing that scale of support. It is time they earned their fees.

The big lesson for us all, is that the ease of capital availability to larger enterprises will always bring the temptation to grow an organization by simple acquisition. This eventually creates organizational sizes that in the event of failure are dangerous to the national interest. We have that now with GM, hobbled for years with the strangle hold of their non competitive union contracts. It is finally broken. Its collapse will massively damage the US economy. Its trip through chapter 11 will resolve the contract problem.

Other companies do come to mind. GE is an extraordinarily well managed company that simply does not need to be under the same corporate roof. Six hundred plus divisions are all operating on a stand alone basis. I guarantee you that if we spun out every one of those divisions, the resulting market value would be far higher that the present. Particularly for it to be a primary asset in Warren Buffet’s portfolio.

Mergers and Acquisitions are the plaything of money managers and is driven by fat fees rather than any net gain. In fact, there is more typically a net loss. They make good sense when a strong mature company is able to provide capital access for a rapidly expanding business. The best example of that was Wendy’s acquisition of Tim Hortons. Ten years on a solid capital diet and Tim Hortons surpassed MacDonalds in Canada and began a sound expansion program in the USA. It did so well, in fact that investors forced Wendy’s to disgorge Tim hortons.

A principal of national; oversight must become the distribution and wise breakup of assets large enough to damage the national interest on failure. In fact, I would go so far as to mandate sharply lower credit availability in such an instance. The risk is clear, so regulate it accordingly.

The big five investment banks needed less leverage several years ago because of their size rather than more. That would have leveled the playing field and preserved them from participating from a dash to the bottom. And if they did not like that, then break up.

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