Too Big To Fail
Dec 17, 2009
Posted by Jody Eisenman | Filed under Uncategorized
Back in 1870, the legendary John D. Rockefeller formed one of the first multinational corporations, an entity that became known as Standard Oil. For the next 40 years, Rockefeller employed a brilliant but controversial strategy. Rockefeller destroyed his competition via price cutting and mergers, and then proceeded to vertically integrate. By 1890, Standard Oil controlled an incredible 88% of the refined oil flows in the United States. In 1911, The Supreme Court ruled that Standard Oil was a monopoly that needed to be broken up for the good of society as a whole. As a monopoly, Standard could, in theory, raise prices unreasonably. Standard was then broken up in 34 different companies. Just to get an idea of the size, some of these subsidiaries included Exxon, Mobil, Sonoco, Chevron, Texaco and Gulf.
Although there are no banks today that rival the size of Standard Oil then, there still exists the concept of “too big to fail”. What this means is that a potential failure of any of these banks (which could include names like Citicorp, JP Morgan and Bank of America) could lead to an economic catastrophe. The current administration is now trying to limit this possibility by putting restrictions on the size and scope of bank activity. In addition, [ast Republican presidential candidate McCain has endorsed a bill that would effectively bring back Glass-Steagall. Back in 1999, congress the Glass-Steagall act which allowed banks to engage in brokerage activities. This led to the mega financial supermarkets that we have today.
While I think financial reform is necessary, I think what’s even more important than restricting bank activity is to limit the leverage that banks can use. Currently, banks, under certain circumstances, can leverage their balance sheets up to an incredible 35 to 1! This number must be brought down to a much more manageable level in order to avoid the financial maelstrom we had last year.
