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September 24, 2008

"Too Big to Fail" vs "Too Metastasized to Fail"

The idea of a company being "too big to fail" is wrongheaded. And I don't mean that no company should therefore require a bailout/bridge/whatever. No, it's just that focusing on size as the main metric is wrong.

What we really want to know is, How quickly will Company X's troubles spread through the economy, if it fails, and with what consequences? In other words, we should be more concerned about spread and lethality than about size, per se. Sure, they're often correlated, but I'd let GM fail -- it would be tragic and painful, but non-lethal -- while letting AIG fail (a company half GM's size) would have been a very, very bad idea.

So, what is the right way to think about this? Well, lethality, spread and the like are biological in nature, and it is the ability of some financial services firms to cause immunological havoc in the societal host that is the problem here. We should, therefore, be much more worried about companies that are "too metastasized to fail" than companies that are merely "too big to fail". It's time to change our thinking.

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