Tuesday, May 4, 2010

Economics by Analogy

Simon Johnson of MIT and The Baseline Scenario draws attention to recent claptrap from Larry Summers (who seems capable of little more):

“Most Observers” Do Not Agree With Larry Summers On Banking

By Simon Johnson

What is the basis for major policy decisions in the United States? Is it years of careful study, using the concentration of knowledge and expertise for which this country is known and respected around the world? Or is it some unfounded assertions, backed by no data at all?

At least in terms of the White House policy towards megabanks, it is currently “no discussion of data or facts, please”.

Speaking on the Lehrer NewsHour last week, Larry Summers said, with regard to the Brown-Kaufman SAFE banking act – which would restrict the size of our largest banks (putting them back to where they were a decade or so ago):

“Most observers who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies, and hurt the competitiveness of the United States.”

“But that’s not the important issue, they believe that it would actually make us less stable. Because the individual banks would be less diversified, and therefore at greater risk of failing because they wouldn’t have profits in one area to turn to when a different area got in trouble.

“And most observers believe that dealing with the simultaneous failure of many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment.”

I’ve looked into these claims carefully and really cannot find any hard evidence supporting Summers’s position – and therefore US policy. To be sure, there have been assertions made along these lines by a few people.

My thoughts:

“…they believe that it would actually make us less stable. Because the individual banks would be less diversified….”

Summers statements like these make it painfully clear that he is making stuff up as he goes along to serve his pre-determined conclusion. It is trivially false that mere size provides a stabilizing buffer. For example, so and so can have one million shares in one company or one million shares in one million companies. Mere size has nothing to do with it.

I would guess that Summers, like many economists, is fond of analogies, since the mathematics of economics is actually quite weak. (First, real economic systems, as should by now be all too clear, are radically non-linear, which is why major players like Goldman Sachs jealously guard their masters of computational methods. Second, the simplifications economists routinely champion are, in the real world, gross over-simplifications, throwing the baby out with the bath water.)

The analogy Summers tacitly relies upon is that with greater size, there is greater inertia. But then the analogy is a little too apt. Greater size results in less innovation, less agility, less flexibility to respond to change or the unexpected.

(How’s that paragraph for mixing metaphors?!)

The thing is, Summers (and Geithner, Bernanke, Paulson, Congress and Obama) like big banks. Big Is Beautiful! Having big financial institutions in the economic world is like having big guns, big bombs, big ships in the military. We can make others cower. Never mind that, again pursuing an analogy, there are a great many examples from history of the smaller, more agile foe, outdoing the bigger. Of course, Summers & Co. are hoping for an economic blitzkrieg — large and lightning fast.