Small Is Beautiful. That was the title of an E.F. Schumacher book which argued that vast organizations were bad for humanity. The current crisis shows the wisdom of the economist’s slogan. The bailout at Citigroup Inc. shows just how ugly big can be.
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After Bear Stearns and then Lehman Brothers went down, it became fashionable to argue that investment banks are safer if they are part of larger institutions. This is nonsense. Bigger banks are just even more frightening, which makes them too big to fail. As Iceland recently discovered, implicit safety can become dangerous when institutions become too big to save.
Citi’s tailspin wasn’t required to show that pure investment banks weren’t the only one that got into trouble. Remember UBS, Wachovia, Royal Bank of Scotland, HBOS and Fortis? None was a pure investment bank, but all suffered huge losses from dabbling in risky assets. Their other businesses did little to cushion the blow. Indeed, the mix of businesses may have made these banks less competent in managing trading operations—or even more reckless. Unfortunately, the crisis is creating even bigger financial conglomerates. Bank of America has gobbled up Merrill Lynch; Barclays and Nomura have feasted on Lehman’s carcass; JPMorgan Chase has snapped up Bear Stearns and Washington Mutual. Unless something is done in the meantime, the next crisis will strike even more behemoths that are too big to fail.
This recent conglomeration is, to some extent, unavoidable. But it is not desirable. The real way to make banks safer is not to make them bigger but make them take smaller risks. And the real way to make the world safer is to cut banks down to size so none is too big to fail.