Back in 2011 NewScientist reported (24 October 2011, paywall) on an analysis of global capitalism and the rule of thumb that some firms are too large to fail:
The idea that a few bankers control a large chunk of the global economy might not seem like news to New York’s Occupy Wall Street movement and protesters elsewhere (see photo). But the study, by a trio of complex systems theorists at the Swiss Federal Institute of Technology in Zurich, is the first to go beyond ideology to empirically identify such a network of power. It combines the mathematics long used to model natural systems with comprehensive corporate data to map ownership among the world’s transnational corporations (TNCs). …
Crucially, by identifying the architecture of global economic power, the analysis could help make it more stable. By finding the vulnerable aspects of the system, economists can suggest measures to prevent future collapses spreading through the entire economy. Glattfelder says we may need global anti-trust rules, which now exist only at national level, to limit over-connection among TNCs. Sugihara says the analysis suggests one possible solution: firms should be taxed for excess interconnectivity to discourage this risk.
NewScientist now presents an extension of the analysis (23 May 2015, paywall) that continues to suggest that interconnectedness may be the key:
NEVER again? The global financial crisis of 2008 saw banks around the world bailed out to the tune of billions by governments worried that the entire financial system was in meltdown. “Too big to fail”, the thinking went, and since then, efforts have been made to increase scrutiny of large institutions. But the latest research suggests a much more sophisticated analysis is needed to prevent another crisis.
We already know that firm size isn’t the only problem in a financial crisis. In 2011, New Scientist revealed that 147 interconnected entities – not all of them large financial institutions – control the network of global capitalism. A problem with any of them could have a significant effect on the system, demonstrating the ongoing potential for vulnerability. …
The Financial Stability Board was created in 2009 to attempt to understand and monitor the situation. They’ve published a list of firms, based on their interconnectedness rather than their size, which, if one gets in trouble, could trouble others. Those meeting the criteria must increase reserves, even at the expense of profitability. From NewScientist:
Most of the emphasis in SIFI designation is placed on this interconnectedness, which has been much studied by academics, along with size, which is easy to determine. To date, relatively little attention has been paid to the third part of the SIFI designation – complexity – says Robin Lumsdaine of American University in Washington DC.
To better understand complexity, Lumsdaine and her colleagues used tools from network science to analyse the corporate structure of a variety of financial institutions, including Goldman Sachs, Barclays and HSBC. The researchers anonymised the firms – identifying them only by their country – and used snapshots of data from 26 May 2011 and 25 February 2013 to see if the firms’ complexity had changed.
Their method involves mapping out a firm’s subsidiaries, and then each subsidiary’s subsidiaries and so on. These “control hierarchy” networks are then labelled according to the country or industry of each subsidiary (see diagram).
Sadly, the diagram is broken on the web page, but the print edition’s view is quite attractive and compares American and Japanese firms. The former is unbalanced and difficult to understand, while the latter is almost pretty in that it appears the subsidiaries are carefully sized to match each other. However, the US firm is characterized as “large”, while the Japanese firm is “small” – the complexity comes in the number of industries involved.
FSB’s work may be having an effect:
Across the board, country complexity seems to have fallen between 2011 and 2013, the researchers found. That’s in line with a recent report in The Economist showing that banks aren’t seeing the expected returns from globalising their operations and are starting to withdraw, says Stefano Battiston of the University of Zurich, Switzerland, who carried out the 2011 interconnectedness work.
Conclusions?
In other words, we may be over-emphasising the “too big to fail” mantra: even small companies can be complex in a way that could threaten financial stability if they failed.
“It speaks to the size threshold as being inadequate,” says Lumsdaine. Regulators already know this, she adds, but the team’s analysis highlights the need for change. “There should be greater focus on complexity and more metrics are needed.”
So Bernie Sanders (I/D – VT) may want to rethink his proposal in light of this fascinating article.
The associated academic article on measuring complexity is here.
Some brief poking at the The Financial Stability Board‘s website did not reveal a helpful list of SIFIs. If I can find them – or a helpful reader provides them – I’ll post them.
