What Can We Keep in Mind?

Perhaps the underlying problem with banks that are “too big to fail” is that they are also too big to succeed.  Unable to be managed effectively, they will almost inevitably stumble and fail.  Earlier this week, The Wall Street Journal offered some tips on the problem. (See “Too Big To Manage.”)  But in the typical up-beat style of business journalism, the Journal underestimated and oversimplified the problem.

It’s not just a matter of size and complexity.  In the early years of this century huge enterprises were successfully constructed for the purpose of extracting natural resources, manufacturing goods, or constructing vast public works, taking advantage of economies of scale to transform our industrial landscape.  There is nothing inherently impossible about size.

But some kinds of organizations are just too unruly to keep in check, to multifaceted to keep in mind.  The variety of tasks they set about accomplishing work at cross-purposes with each other.  And this may well be true of our financial behemoths.

Paul Volker, for example, has made the unpopular but sensible suggestion to reinstate the separation of commercial and investment banks mandated by the Glass-Steagall act.  Recent experience has amply demonstrated the need to better manage the conflicts of interest their separation was designed to prevent.

An additional problem is managing the entrepreneurial and competitive spirit contained within huge financial institutions.  Aggressive managers will inevitably use their positions to conceal or downplay the risks they take in order to make greater profits – and gain advantage over their peers.

Then there is the problem of bloated and dysfunctional bureaucracies, as managers chase new ideas to try to gain control of their departments while competing with each other for advancement.  In this environment, new ideas hardly have the chance to prove themselves before they are displaced by still newer and more enticing ideas.

Big banks are not the only ones that suffer from these problems, but the bigger the bank the more opaque the view inside.

I can understand the desire to believe that these organizations can be successfully managed, but those who think so are too often the ones who stand to gain from the chance to try.  That’s the problem in a nutshell.