The Economist gets it wrong, again
About 10 days ago, The Economist published three articles on General Electric and mixing industrials with banking. Those articles follow GE’s decision to divest its banking business, GE Capital.
GE shows why industrial firms should avoid owning big finance operations. Occasional successes such as Warren Buffett’s Berkshire Hathaway can combine insurance with hot dogs. But most manufacturers are even worse at managing financial risk than banks are—and they are harder to supervise. A blow-up at the finance arm can sink the entire company.
In another short article, the newspapers attempts to warn industrial CEOs not “to turn your firm into Goldman Sachs”:
The case for a split is clear. Managers are even worse at dealing with financial risk than bankers are. A blow-up in a firm’s financial arm can hurt its main business. And giving tycoons access to savers’ cash can lead them into all sorts of temptation.
Well, that’s not really true. What The Economist is describing is the situation in which a few large companies have been allowed to set up banking arms. This is indeed a situation to avoid as it limits entrants in the market and as a result gives an artificially high market share to those who could set up banking activities, which often transform into TBTF entities and put their parent company at risk if ever they fail. In the end, you end up with a few huge banks and a few very large banking arms owned by non-financial corporations. But this is not a free market outcome. The Economist is suggesting that we restrict banking to banks. It will not make the TBTF problem disappear but reinforce it.
We want the exact opposite of what The Economist is describing. We want every single company, every Google, Amazon, Apple or Walmart, to be able to set up a banking or finance arm if it wishes to, as long as it believes it can convince customers that it is able to provide a cheaper and more efficient alternative/product*. The more banks on the market the more likely market shares are going to be granular and the balance sheet of each entity limited in size. In turn, this competitive landscape would make the TBTF issue disappear and customers benefit. Finally, as each banking entity remains relatively small under competitive pressure, it is also less likely to endanger the financial health of its parent company (or of the whole banking system) if ever it collapses.
*And many of those companies are already entering the financial systems, in particular in the payment space, with some success.