A Corporation can be "too big to fail"

Thanks for the response darkkermit. ==Rebuttal== My opponent cites a number of economic concepts but none of them prove that a corporation cannot become "too big to fail." R1) The Role of Profits All of my opponent's arguments here assume a) multiple firms in a competitive market and b) relatively elastic demand. Darkkermit himself says that a lack of profits means either a) too many competitor firms or b) a lack of demand (which is not possible if demand is inelastic). However, all of my arguments deal with industries that have a) very few firms and b) inelastic demand, meaning an inability of consumers to consume less or to switch to other products. So darkkermit's arguments don't apply. R2) Opportunity cost and scarcity Darkkermit argues here that a firm that is "unprofitable" is wasting resources. This is true. A firm that CONSISTENTLY (each business Quarter) fails to turn a profit IS wasting resources. However, firms go bankrupt for reasons OTHER than failing to consistently turn a profit. Often times, although a firm consistently turns a profit each quarter, the firm takes a huge, temporary loss that it cannot cover. After a bailout to cover the firm's losses, the firm is more than able to return to turning a consistent profit. If anything, letting the firm go bankrupt is wasteful because it is still a potentially profitable firm. I'll offer two examples: 1) if there was a temporary one-year drought, Monsanto might be in danger of going out of business, but could survive if the government covered its temporary losses; 2) Goldman Sachs lost too much money in the 2008 Financial Crisis, but was able to return the government's bailout money after only a few months and return to profitability. I'll agree with darkkermit that the government should not bail out firms in markets where each firm is small and there are a large number of competitor firms. I'll also agree that the government should not bail out firms in markets where demand is relatively elastic. I only argue that businesses in essential industries (food, power, and financial services) can become too big to fail. R3) Bankruptcy reallocates resources Economists are always stressing the difference between the LONG RUN and the SHORT RUN. Creative destruction occurs in the LONG RUN. Eventually, if a large monopoly goes bankrupt, smaller and more efficient firms will move in to take its place. However, in the short run, the bankruptcy of a large monopoly causes what we call a "supply shock," which is a huge disruption in supply that causes a massive spike in prices. The problem is, as I argue, that in essential industries with inelastic demand, the short run supply shock that occurs for the first 5-15 years causes too much damage before the long run benefits start materializing (after 15-40 years). If the economy cannot survive the short run shock, then the long run benefits don't matter. Also, when a company goes bankrupt, it means there is an inefficiency in the MARKET, not necessarily the firm, and we may not like the way the market reallocates resources. For example, in the food industry, the market may decide that there are too many mouths to feed, and we cannot do it without a monopoly, so the market's solution to this problem will be smaller farms and mass starvation. The market may decide to eliminate demand, rather than shifting supply elsewhere. My opponent discusses bankruptcies in the "carriage industry," "telegram industry," and "Blockbuster," but none of these is in an essential industry with inelastic demand. By definition, because there are plenty of alternatives in these cases, demand is ELASTIC, meaning consumers can easily switch to a related product. I would agree that we should let the firms darkkermit cites go bankrupt. R4) Response to darkkermit's rebuttal Darkkermit says I assume that when a company goes bankrupt, its resources do not magically shift to other companies. This seems to be a reasonable assumption, and darkkermit is clearly misunderstanding what his sources mean by "reallocating resources." If an oil company goes bankrupt, the market allows another oil company to seek out oil instead. But it's not like everything that the bankrupt firm had suddenly goes to other companies. If Monsanto went bankrupt, no other company could suddenly swoop in and produce millions of seeds, even if Monsanto's factories were all put up for sale; it takes A LONG TIME to rebuild Monsanto's expertise and rehire or retrain thousands of employees, and it takes too much capital to buy every single factory. In fact, because of patents, no one would EVER be able to reproduce Monsanto seeds. In the LONG RUN, Monsanto will be replaced, but in the SHORT RUN, no one will be able to QUICKLY reproduce its seed production capacity. So we run out of food in the short run. Or a better example of how resources are NOT conserved when a firm goes bankrupt is: a run on a bank. Commercial banks take deposits from people and then make loans using that money. So these banks do not have enough cash in their vaults to pay every depositor if they all come calling at the same time; the banks need the debtors to pay them back before they can return all the deposits. Typically, banks only keep enough cash on-hand to cover 10% of their liabilities (money owed to other people). A "run on the bank" occurs when a crisis - such as the financial crisis prior to the Great Depression – causes people to panic and demand their money all at once. After the bank pays the first 10% of people, it runs out of money and declares bankruptcy. The remaining depositors all lose their money!! How are resources "reallocated" in this case, as darkkermit suggests? When a bank goes bankrupt, wealth is permanently destroyed; it is NOT conserved. ==My case== Let's begin with the dropped arguments. 1) Burden of proof Remember, the following banks received bailouts: Fannie and Freddie, Citigroup, Bank of America, AIG, Wells Fargo, JP Morgan Chase, Morgan Stanley, Goldman Sachs, American Express, Comerica, Capital One, Lincoln Financial. Darkkermit fails to explain how the simultaneous failure of all these banks would not have hurt the economy. 2) Monsanto and PG&E Darkkermit doesn't respond to these two examples of companies in essential industries. He fails to explain how the economy can weather a lack of food and power. His only potential response is creative destruction, but this only occurs in the long run. The economy can hardly survive without food and power for 5-10 years or more. So if a monopoly in the food or power industry went bankrupt, we'd be really screwed. Even if some smaller firms could start producing food or power, they would not produce anywhere near ENOUGH to replace the monopoly. The result will be a supply shock, which means a massive increase in prices. Only the rich would be able to afford food or power. Consider the following example: OPEC's oil embargo of 1973. OPEC is a cartel but it can be treated, for our purposes, as an oil monopoly (at least it was a true monopoly in 1973). When it severely restricted supply in 1973, this had a DRASTIC effect, but a LESSER effect than if OPEC had gone bankrupt and ceased to exist. If darkkermit is right, the contraction in OPEC supply SHOULD HAVE led to other firms taking over oil production. But it did not, at least in the short run. If OPEC had gone bankrupt, rather than restricting supply by 50%, it would have restricted supply by nearly 100%. There is no reason to believe, given our inability to replace 50% of our supply with other suppliers, that we would have been able to replace 100% of our supply. According to a study by NYU, the 1973 oil price shocks destroyed 1.2% of disposable income in the U.S., which is approximately $100 billion. [1] [2] The shock would have been much worse had OPEC not ended the embargo after only 6 months or had they cut off ALL supply. If we cannot replace an oil monopoly in the short run, there is no reason to believe we could replace a food monopoly or a power monopoly either. New argument: 3) How banks became too big to fail The following is borrowed heavily from Charles Morris' "The Two Trillion Dollar Meltdown." With the repeal of the Glass-Steagall Act, commercial banks, investment banks, and insurance companies started combining into enormous mega-banks. This was a big problem. Commercial banks and insurance companies had suddenly taken on the risks of the investment banks, by combining with them. Investment banks had always made risky investments, like investing in mortgage-backed securities, but before the repeal of Glass-Steagall, an investment bank that made bad investments would merely go bankrupt. If it insured its losses with an insurance company, its investors would still get their money back. However, by combining with insurance companies, investment banks ensured that if they bankrupt their parent company, the insurance arm of said company would have no money left to cover financial losses. Secondly, by combining with commercial banks, investment banks ensured that they were wagering OUR savings accounts into extremely risky ventures, like mortgage-backed securities. So if the mega-bank went bankrupt, we would lose our savings accounts as well. This FORCED the federal government to bail out the banks because they would have had to pay either way; it was either a bailout OR FDIC (federal deposit insurance, up to $100,000) would have to cover the loss of every savings account in the country. When the banks were separate, the failure of risky investments would only bankrupt the small investment banks. Combined, however, risky investments spread the risk throughout the ENTIRE financial system. Add to that the concept of leverage, and the situation is even more troublesome. Using leverage, investment banks allow investors (and themselves) to use $1 to make an investment of more than $1. Consider an anology: if a casino let you do this, here is the way it would work. You would go to the Roulette table with ONLY $1 in your pocket. The casino would let you place a bet of $30 on black (a leverage ratio of 30-to-1) using only your one dollar bill. If you won, the casino would give you $31 (your $30 in winnings plus your original $1), but would keep the $29 of their money you used to make the bet. If you LOST, you'd owe the casino $29 dollars. That's how leverage works. Prior to the financial crisis, Bear Stearns was leveraged at a ratio of 33-to-1. At this ratio, a 3% loss wipes out the entire company. These kind of risky bets are fine when the investment bank is just betting its own money, but it is NOT fine when it is also betting people's insurance policies and their savings accounts. Credit default swaps were a way for banks to INSURE their risky investments (mortgage-backed securities). A mortgage-backed security is essentially a bundle of individual mortgages that an investor can buy. Investment banks, at this time, demanded high rates of return and by definition, more risk leads to greater returns, so banks would cut out the safer mortgages, and started only bundling the risky mortgages (subprime mortgages) together. They KNEW these investments were risky, so insurance companies started issuing a credit default swap, which means that if you lost money on the mortgage-bundles (securities), the insurance company would pay back the losses. The reason that when Lehman Brother's failed, this touched off the financial crisis, was because Lehman Brother's had been issuing credit default swaps to investment banks. When banks realized that their financial losses from the mortgage crisis were no longer insured, chaos ensued. So here's the chain of events: (1) The mortgage market goes sour. (2) Mortgage-backed securities take huge losses. (3) Investment banks are leveraged at high ratios of around 30:1. (4) This means that a 3-4% loss in the market for mortgage-backed securities will bankrupt the PARENT company. (5) Parent companies went bankrupt, meaning they ran out of money. (6) Parent companies, because of the repeal of Glass-Steagall, also included commercial banks and insurance companies. (7) Since the insurance companies were now bankrupt too, they couldn't cover the financial losses they were supposed to cover. (8) Since the commercial banks went bankrupt too, our savings and checking accounts were gone too. (9) The government had no choice but to bail out the banks. If Glass-Steagall hadn't been repealed: (1) Investment banks lose money. (2) Insurance companies, being separate, still have capital to cover the losses. (3) Our savings accounts are safe in a completely separate bank. And that's the story of how the repeal of the Glass-Steagall Act caused banks to become too big to fail. Vote Pro. [1] http://people.stern.nyu.edu... [2] http://www.euromonitor.com...