January 10, 2011
A Perplexed Economist Confronts 'Too Big to Fail'
Posted by D. Daniel Sokol
ABSTRACT: This paper, written for a conference at the Fordham University Law School, examines various facets of the “too big to fail” debate. It notes that in the current context, “too big to fail” may imply systemic risks from large financial institution size, compensating economies of scale, political power, and (within narrower markets) power to set prices above competitive levels. It examines three stylized facts: the contours of the recent merger wave among financial institutions, the concomitant increase in the concentration of financial institution assets, and the impressive rise in financial institutions’ profits as a share of all U.S. corporate profits,. It argues that rising aggregate concentration of financial institutions’ assets may imply rise in the power to set above-competitive prices in individual relevant banking markets – i.e., in segments of what economists call “product characteristics space.” There is not much solid economic evidence on this last conjecture for investment banking firms, but supporting evidence from the large number of studies focusing on commercial banks is marshaled. The evidence on economies of scale is also imperfect, but it implies that breakup of the largest banks need not cause great efficiency losses.
January 10, 2011 | Permalink
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