Friday, December 19, 2008

Breaking up Financial Behemoths

I am seeing a rising future consensus opinion on the need to force an end to gigantism in the corporate world. It is stated very simply. If it is too big to fail, then it is too big and must enter upon a planned dismemberment. There needs to be legislation and a court ordered process. Trust busting legislation shows the way quite well and we have had the recent example of AT&T to inspect.

GM is the obvious current example that certainly calls for this type of treatment, and while we are at it, it needs to be applied to a couple of the other global manufacturing behemoths.

More importantly the financial behemoths that are all been bailed out need the same treatment. Does anyone think that AIG and Fanny Mae and Freddie Mac and their ilk actually successfully managed their capital exposure? The truth is that they all jumped onto a race to the bottom that was incentivized with bonuses and they could not get off or correct it and maintain their illusionary profit performance. There was obviously no way to correct it without getting fired.

They have all been smashed and it is now an excellent time to spin out the successful sub units that can still stand alone. And perhaps we can return to the good old days in which cross investment was banned. It never made sense ever to have brokers be in the same office as a lender. The conflict is always fatal and the incentive to grab is overpowering.

There is also always a lawyer to package any scheme.

Who will not borrow money in the hopes that sometime later he can liquidate it all and walk away rich. A banker has to know better than that.

Today our primary source of available leverage, the housing market, is completely under water. It is a good bet that no one who acquired real estate in the past ten years is able to liquidate and is trapped with paying off the property in the hopes of seeing daylight.

I think that one of the best stimulus methods that could be applied to the US economy and the global economy is to order a breakup of all the obvious behemoths, as soon as possible. A ten fold increase in banking competition will revitalize the lending market for the newly emergent independent manufacturers.

The so called efficiencies of management redundancies have turned into a mirage. The errors incurred have destroyed the entire capital base of the financial industry and many others besides. GMAC has great business if it can get money to lend on good terms. A little more difficult when the several biggest lenders have shrunk hugely. A little easier if supported by an army of small lenders and operated as several smaller GMACs.

One way to promote corporate breakup is to create a credit formula that actually penalizes dangerous sizing. That would remove the strongest incentive pushing corporate gigantism. The events of the past quarter would actually support such a formula by the credit rating agencies. I am stilled startled to wake up and realize that triple A firms abruptly failed. It should never happen.

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