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Short Paper: Too Big to Fail Essay

After the financial crisis in 2008, there were many famous economists started their analysis about the causes of this crush. Many of them published their own books aimed to discuss the existed problems in the capitalism system. After looking through these books, I found out a book, Too Big to Fail, is written by Andrew Ross Sorkin who is the chief correspondent and columnist of New York Times. This is an interesting book which also had been adapted for film by Curtis Hanson in 2011. “The author delivers the first true behind-the-scenes, moment-by-moment account of how the greatest financial crisis since the Great Depression developed into a global tsunami. From inside the corner office at Lehman Brothers to secret meetings in South Korea, and the corridors of Washington, Too Big to Fail is the definitive story of the most powerful men and women in finance and politics grappling with success and failure, ego and greed, and, ultimately, the fate of the world’s economy.” (Andrew, 2010, p. 4) Based on the point of Andrew, “Too big to fail” means several financial unions are so big that they could have serious influence on system risk.

Because the executives combine their companies with the whole capitalism system together, taxpayers needs to give their money to save these companies in order to prevent the collapse of the economy. (Andrew, 2010, p. 8) The book mainly focuses on discussing such dilemma: Because these large-size companies believe taxpayers would cover the high risks of big losses from their derivatives and large investment, their companies would be willing to take such actions to make great profits. Although the government let Lehman Brothers bankrupt at the initial stage of the financial crisis, finally the government still use the money from taxpayers invest in those large-size companies in order to keep the capitalism system stable. These large-size companies are also existed in China. Although there are some differences between the capitalism system in United States and the socialism system in China, these large-size companies, such as China National Petrolem Corporation (CNPC) and China Petrolem Chemical Corporation (CPCC) which have a monopoly over oil, also have serious influences on the whole socialism system in China. (Lu Zhang and Yue Yang, 2012)

If they suffer from a big loss and are on the verge of bankruptcy, Chinese government has no choice but to save these companies. How to deal with this problem? There are three theories discuss the possible methods to solve the “too big to fail”, especially in the banking industry. The first one, the government should divide the large-size banks into small ones, is proposed by the former U.S finance minister George Shultz. Based on the argument of Mervyn King who is the governor of the Bank of England, there should not exist only four banks in England and the government need to let the public reduce the concentration of business activities of citizens. (David Wessel, 2009) However, there exists an opposite argument that the size of the company does not matter, as Lehman which is a medium-size company also bankrupted during the financial crisis in 2008. Moreover, if the government divides the large-size companies into small ones, this action would increase the system risks. The second theory is proposed by Paul Volcker who is the former chairman of the U.S Federal Reserve.

He considers the government should let the mortgage and deposit activities be separated: The daily operations of deposit banks would be strict supervised. In other words, the government would secure their deposits and restrict their transactions. The government should not secure the transactions between the large-size banks and companies. (David Wessel, 2009) This method would have negative effects on the profits of large-size banks and a difficult to distinguish different kinds of transactions. Because of this, it would be hard to implement. The third one is proposed by Ben Bernanke, Timothy Geithner and Bayney Frank who are the temporary chairman of the U.S Federal Reserve, Finance minister and the former chairman of the House Financial Services Committee. They considers the large-size banks should be required more capital funds than before, and they need to hold a higher percentage of capital funds than those small or medium-size banks. (David Wessel, 2009) Based on this theory, these companies could have enough money to protect the whole capitalism system when they are on the verge of bankruptcy. If next financial crisis happens in the future, the government could refuse the financial aids to these banks and collect taxes from their next losses.

This theory would be fit for current situation and solve the “too big to fail” at some level. Except these three concepts, there exists another option to solve this problem. Chinese government tries to let these companies be privatized so that they could join in the competition. When these companies have competitions with other companies, they would become efficient and prevent some high risky projects. (Xianfeng Yu, 2007) However, because these companies are in resource and banking industry, these large-size companies could not compete with other companies like other industries, such as the food industry. The government needs to have a strict control of these areas in order to ensure the safety of resources and economy. This is a fundamental factor causes the “too big to fail”. In the traditional capitalism system, the government should let the market operate the whole capitalism system. However, during the financial crisis in 2008, the government forced large-size companies which are still competitive to merge with other companies which are on the verge of bankruptcy. (Andrew, 2010, p. 44) Based on the argument from Andrew, this phenomenon represents that politics and economy combine with each other in the capitalism system. (Andrew, 2010, p. 67)

The high level executives from the government directly affect the decisions of large-size companies, because they need to be responsible for the benefits of taxpayers and the future of economy. The shortage of the capitalism system could be solved by politic interventions. However, the capitalism system would become similar to socialism system. There is no doubt that the time let the market control everything has gone. Based on the idea of Jean Tirole, who is the winner of the 2014 Nobel Prize in economics, we should establish strict supervision laws and regulations to prevent banks from using money from taxpayers to play gambling. “If they want to be saved, they must be supervised strictly.” (Xue Jiao, 2014) He holds the idea of that government should take strict supervisions of all large banks, and these banks should be treated as small banks which do not have privileges of “too big to fail”. However, the supervision does not aim at take the functions of large-size companies and banks like socialism. In opposite, the supervisions from the government is to build up the game roles.

Following these roles, the companies would prevent their error behaviors and let the whole capitalism market have a health development. Except discussing the “too big to fail” problem, Andrew also discuss what kind of factors would have influences on the market condition. At first, he considers that the confidence of the investment banks on Wall Street is an important factor which affect the market condition. (Andrew, 2010, p. 56) Because the financial enterprises does not like manufacturing companies which produce physical products, their business patterns are mainly based on the predictions. Because of this reason, if the expectations about the future market conditions from the financial enterprises on Wall Street are pessimistic, the market would be just crumble to dust. On the other hand, information also would be an important factor which has a big influence on the market condition. In the financial market, there always exist rumors which affect the decisions of investors. Because it is really hard for investors to tell whether the information is true or not, many speculators use this to make money. For example, there existed a news for the former general manager assistant of Yili Milk used insider information to make money from speculating stocks of the company in 2011.

Although the authenticity of this new was not identified, Yili Milk stock had been falling in lock step. (Zhikui Ou, 2011)This case represents how rumor destroy the stock market. Another example is Muddy Waters which is a research and hedge fund company. This company is famous of its research report about list companies in U.S. capitalism market. Before the company discloses the legal behaviors from those listed companies, Muddy Waters shorts stocks from these companies in order to earn huge revenues. (Junheng Li, 2012) The function of stock market is to help those companies which have good project but do not have enough funds, not to let speculators make money by arbitrage or other options. If there exists the company make revenues from buzzing rumors and shorting stocks, the whole capitalism system would be destroyed in a short time. In order to prevent the collapse of the capitalism system, the government should eliminate the legal behaviors of listed companies, standardize stock market information regulations, give serious punishments to those make money from buzzing rumors and try their best to decrease arbitrages.

Except the supervision from government agencies, investors also should find out the useful information and try to dig out the truth from them. Andrew has mentioned a example in his book: When Lehman announced its excellent performance report and recover plan, Michael Mayo who is the famous analyst in Germany could find out that Lehman is too optimistic to evaluate its own assets. Its performance report and recover plan simply does not hold water from reality. (Andrew, 2010, p. 99) However, this needs professional knowledge of finance and accounting. Most of normal investors do not have such knowledge to filter information and dig out the truth. In China, almost all of my close friends who join in stock market do not have enough knowledge of finance and accounting, they just listen to the advises of financial analysts in financial programs and follow the “hot issues” to hype. They consider hyping stocks is a way to make money in a short term as gambling, not as the long term investment. In a way, the greed from those people cause bubbles existed in the stock market and huge losses in the end. (Andrew, 2010, p. 170)

There are many interesting things mentioned in this book. First of all, under the serious situation caused by the financial crisis, these big men also used traditional methods to solve problems, such as the example New York Federal forced the biggest nine banks to save the Richmond Federal. The executives of nine banks were divided into three groups to target at one issue to solve and reported the outcome a few hours later. This represents the methods we used to solve the common problems which give us good weapons to deal with serious problems under the high pressure situations. Secondly, the author delicately described a person in his book. For example, Andrew described the CEO of Lehman, Richard S. Fuld, in detail. (Andrew, 2010) From the description of Richard in the book, we could find out that his experience of saving the company in many serious situations led to his swagger, and finally caused the bankruptcy of Lehman. However, different from other people just consider their own interests, the behaviors of Richard was not only driven by the greed, but also the love for his company, Lehman. Another example is the former U.S Finance Minister, Henry Paulson.

Although he did a lot and prevented the outcome become more serious than expectation, he still be blamed because the public considered he should take the responsibility of the happening of the financial crisis in 2008. In this book, Paulson was just a normal people who lived with his wife in a small apartment. He would be driven to be mad by the tough situations and tired of dealing with difficult problems in a short time. (Andrew, 2010) Although Too Big to fail is included in the department of Economic Conditions or banking from book dealers, this book is more like a fiction. Many activities and people mentioned in this book are rhetorical, for example, the former president of United States, George Walker Bush, although Paulson tried his best to explain the terms we used in Wall Street, Bush did not understand at all. (Andrew, 2010, p. 133) Bush was like a stupid politician who were completely clueless about basic knowledge of finance, which is unbelievable.

Warren Edward Buffett, who was the most famous investor in the world, accompanied his grandson to the dessert shop after hanging up the call from Goldman Sachs in a hurry. (Andrew, 2010, p. 140) There is no doubt that these stories increase the fun of reading, but the authenticity of these stories is decreased in the meantime. In conclusion, although the government and the public work hard for fixing the problems appears in the financial crisis in 2008, there are still some inherent problems existed in the capitalism system, such as the “Too big to fail” and the greed of people which cause the bubbles exist in the stock market. Under the existing economic and social development situation, we need to accept these phenomena and have a continuous development of the capitalism system in the future.

Andrew Ross Sorkin (2010). Too Big to Fail. Penguin Books.
Lu Zhang and Yue Yang (2012, December 17). The monopoly of China National Petrolem Corporation and China Petrolem Chemical Corporation. Finance Magazine. Retrieved from http://business.sohu.com/20121217/n360638179.shtml David Wessel (2009, October 28). Three Theories on Solving the ‘Too Big to Fail’ Problem. The Wall Street Journal. Retrieved from http://online.wsj.com/articles/SB125668497563411667 Xianfeng Yu (2007, Augest 27). The privatization of China National Petrolem Corporation and China Petrolem Chemical Corporation. Shanghai Stock Newspaper. Retrieved from http://www.cnstock.com/newcjzh/06cjdt/2007-08/27/content_2477411.htm Xue Jiao (2014, October 15). Jean Tirole: The Banks should not Too Big to Fail. First Financial Daily. Retrieved from http://stock.sohu.com/20141015/n405120867.shtml Zhikui Ou (2011, June 14).
The Yili Milk stock had been falling in lock step. Nanfang Daily. Retrieved from http://epaper.southcn.com/nfdaily/html/2011-06/14/content_6973033.htm Junheng Li (2012, August 17). Is Muddy Waters Profiting From Research Or Rumor-Mongering? Forbes. Retrieved from http://www.forbes.com/sites/china/2012/08/17/is-muddy-waters-profiting-from-research-or-rumor-mongering/

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