Too big to fail? Is that a healthy place to be in?

Over the last few weeks, I have heard the audio book of Too Big To Fail by Andrew Ross Sorkin as well as watched the movie based on the same book, which outlines with some good insights on the 2008 credit crisis, the actions/intentions of the various key players involved and the catharsis which started with the fall of Bear Stearns and ended with the massive bailout of the financial industry by the US government through the TARP Plan. Towards the end of the movie, Cynthia Nixon (of Sex and the City fame) who essays the role of Michelle Davis(who was at that time, the Assistant Secretary of the Treasury, Public Relations) makes an interesting comment on the bankers resistance to participate in the TARP plan which kind of put things in perspective.

“These guys bring down the entire financial system. And we can’t impose any restrictions on the money that we give them to stabilize themselves because they won’t take it”

The comment is quite profound and quite bewildering to a normal observer but it comes as no surprise to those who have been through the “Too big to fail”(TBTF) phenomenon. Corporate as well as world history is littered with organizations (political/corporal/military) which also grew to a position of being TBTF and then came crashing down in spectacular fashion. The empire of Alexander, the Roman empire, Hitler’s 3rd Reich, the Soviet Union are quite a few that come to mind instantly. The corporate world especially over the last couple of decades is littered with Enron, Worldcom, Bear Sterns, Long Term Capital Management(LTCM), Lehman Brothers, AIG to name a few.

Looking at the rhetoric around “Too big to fail” makes me wonder if this exalted position is really something that an organization should aspire to achieve. Well, it does offer some compelling benefits

• Gives it unique arbitrage (read bullying) opportunities. Gives it additional leverage to arm twist competitors/suppliers/employees and even customers. (Does anybody remember Enron and California?)
• Gives it an opportunity to become a monopoly
• Aids it to influence government policies.
• Offers greater opportunities to gobble up (read M&A) smaller competitors.
• Offer additional/new pockets to hide losses/misappropriations as much as possible
• Sell the “success story” to an extent that the halo around tends to sound like the real truth.
• Does keep the shareholders happy. However bear in mind, the shareholders that matter to the corporate are only the institutional investors who buy in chunk and not the singular retail investors.

However the biggest learning from history is that almost all of these benefits are “short term pleasures” and the support structures that help create these benefits are extremely fragile.  A organization which is reaching the TBTF position also inherits the following pains which significantly dwarfs the short term pleasures specified above

• They become fat and sloppy (like some of who are fighting a losing battle against body weight). They lose the ability to be agile to market changes. Even if they are, getting the entire organization to turn rapidly around proves almost gargantuan
• The arrogance which comes naturally with the TBTF position leaves tons of bad taste/enmity in the entire ecosystem. The TBTF corporate inherits the maximum number of folks who actually want to see it fail.
• Leaves the corporate open to leaks all over the place. The sheer size means that the possibility of leaks increases almost exponentially. A significant amount of senior leadership effort goes away in handling the leaks as opposed to thinking about the future (The story about Westinghouse is a good example of this phenomenon)
• Ultimately leads the management to adopt a ponzi scheme. Whether it is Hitler’s policy to keep the war machinery going in the 1930s in Germany (and building the halo of a post-depression growth explosion) or Enron trading its energy products in the form of spurious derivatives or the complex mortgage based derivative instruments that created the credit crisis, all of the TBTFs have ultimately landed themselves in ponzi schemes

So who really benefited from the TBTF firms? It is probably the rich banking fraternity or the leadership of these firms which ripped the firm off during its heydays by getting dividends/fat salaries/bonuses or capital gains by buying at a low and selling at a high (by getting insider information). The rest of the ecosystem(The employees, customers, supplier, retail investors) has had to deal with the excreta left behind due to these excesses.

Interestingly another lesson that history teaches us is that this phenomenon never really goes away. As Gordon Gekko (played so adeptly by Michael Douglas in Wall Street) says “Greed is good”, the anger after the fall of a TBTF firm is invariably replaced by investment in another similar entity which then over the next decade attains the TBTF state and then the next disaster happens.

Research done in this area like the ones documented very articulately in the book “Built To Last” by Jim Collins and Jerry Porras does allude to the fact that the more successful or enduring firms have been the ones that have learnt from these mistakes and have learnt to stay agile even if it means that they don’t reach TBTF status. Wall Street is of course a strong exception to this rule. Another recent movie that I watched, “Margin Call” illustrates this very well. Towards the end of the movie, when the CEO of the fictional wall street firm, talks to his head of trading portrayed by Kevin Spacey, he talks about the different disasters (read crashes) that have enveloped Wall Street ever so often and how that the Wall street firms are helpless. They seem to have made a business of just creating products and services which lay the basis for the next crisis. The ones that survive the crashes are so greedy to make money from the opportunities that arise from the recovery that they achieve TBTF status very fast by indulging in a number of activities(many of which are beyond scruples) geared to make sufficient money to survive the next crisis.  However they may also be reaching their nadir as this time around, they needed Japanese/Middle East/Chinese financial institutions to actually bail them out this time.

So the key question for corporate leaders or governments is that whether they want to reach the TBTF status? How often do we say “How the mighty have fallen”?