Of late, when you hear the news of bailouts by Governments, it will be linked wit the words that it has to be done because the banks are “too big to fail”. It may make one to wonder why if it is too big, then it cannot fail. If failure only applies to small players, then it seems that the playing field is to advantage of big players. It does not matter what you do, as long as you are a big player, the governments would not allow you to fail. This is the message that is what’s troubling me.
In this article, I would like to, first explain on what is meant by “too big to fail”; then explain about the problem that it poses in the long haul in regard to what is termed as the “moral hazards” as the economist generally used to explain it; and finally relates to what we can learn from the ongoing issues in regards to these “bailouts, too big to fail, and moral hazards” business.
Why Citibank, the big three US automakers, AIG, and others who are “too big” cannot be allowed to fail? The answer is very simple: the ripple effects are so large that it will be a total systemic failure (in case of banks – to financial system; in case of automakers – to the industrial base of the country). The banks (e.g. Citibank), are part of the symbiotic and intricate financial system, that practically is present in almost every facets of other banks and financial system. If they fail, it will cause a massive bank runs, and it will trigger and starts an overall panic that will make the whole system to crash. It is simply a scenario that won’t be acceptable to anyone and by any means: because when that happens, even the governments won’t be able to do anything, and the damage will be so severe. In regards to US automobile industry, it may be a bit different, because it is not the financial system that is at risk, but the overall industry is. Therefore, despite the emergency calls by these companies, the US Government is not as fast to just readily agree to their bailout program. The difference here is one is systemic failure, while the other is not.
The question that may be raised (which somehow has been avoided in the mainstream media): is why the governments did allow these companies to grow so big, and became almost a “monopolistic entity” to begin with? Why do we have such “monster” companies that eventually became something that eventually point the gun to the governments and tax payers that says: “save me, if not I am going to kill you”, kind of thing?
If that is the case, we can also imagine that one day, for example, in the case of Malaysia, the IPP (independent power producers) can say to us that, we have to save them if not the nation will have an immediate blackout! Or we can have the telecommunication companies that will ask us to save them, if not we will be totally out of communication systems, and so on. We may not realize it that in Malaysia, our TNB is almost at the mercy of the IPP’s by certain measures. Similarly we cannot UEM fails because almost the entire nation’s highway system will “go along with it”. In fact the government did save Renong (the predecessor to UEM) after the 1997 crisis, because it was at a clear risk of falling into foreigner’s control (at the time).
This is where the issue of moral hazard came into the picture. It is well known among economists that moral hazards are bad for the economy and is very costly. First, let me just explain what moral hazard is about: it is about when someone (in this case, the management or shareholders of the company), takes decisions (whether risky or not) for the company that will benefits them; and yet let some one else bear the costs of their decisions should anything went awfully wrong with their decisions (in this case the taxpayers); and they will walk away freely (with possibly some smaller losses on their part, compared to the cost to the taxpayers). All these “bailouts, and too big to fail business”, are clear examples of moral hazards. The funny part is that all of these are done, accepted, and approved by everyone, including many economists and governments alike. Most of them fail to see or raise the issue that all these moral hazards are a result of the design of the system: that is to favor the big players. That is the asymmetry that I would like to point out.
In the case of Malaysia, we have many examples of highly concentrated dependence and reliance on “big players”. For example, our banking system has been always geared towards only big banks. The mergers and acquisitions by local banks over the last 15 years are to create “lesser number of banks, with much bigger sizes”. The same trend is also true: we create one massive plantation company by the name of “Synergy Drive” and in the process eliminate two plantation and property companies, by merging them into one. Today, by having the palm oil prices at a new low, the whole Synergy Drive Group is badly affected. Similarly, by having big government owned companies who has the capacity to monopolize the market, we are squeezing the smaller players into disadvantaged positions. So are we going to continue on this trend, and may be one day we will face the same question that it may be too big for us to let it fail? Are we then inviting moral hazards to come into play? By having only a few to decide on what can happen to the company, and if any major trouble come, they will just let the taxpayers to have it?
I believed that in light of what’s going on, we should seriously review these policies and approach. The mantra that “big is better” may not necessarily hold true; and may only be the case in exceptional situations. Anecdotally, in the case of construction industry, I have seen smaller Malaysian companies thriving and performing well in overseas market, compared to the mammoth of UEM, which most of the times failed to perform in an open market environment. May be we should review our policy by supporting smaller and more vibrant players from our market as they venture overseas and developing markets and jobs for Malaysians abroad. May be, we also allows smaller and organized players to enter into domain that are generally thought should be allowed only for big entities, such as in the financial services arena. While these suggestions are general in nature, I believe that they have merits to be thought out and deliberated properly so that we can take lessons from what’s going on and hopefully use for our own advantage.
If statistics is of any help: the law of large numbers say that if an average 30% business will fail; then if we have 100,000 businesses, 30,000 of them will fail; while the number sounds a lot, their failure will not affect others. But in case of when we have only 10 companies, if 3 of them fail, and furthermore since they are not independent from each other, all the 10 will fail as well – is a not acceptable scenario.