From the New Yorker.
Why am I too big to fail? It’s important to grasp the critical role that I play in a wide-ranging but fragile web of economic relationships. If I go belly-up, I will no longer be able to tip my doorman when he gets me a taxi. This is not a hypothetical situation. I have studiously avoided tipping him for a solid month now. Consequently, he no longer has cash to spend at the liquor store after work, and the liquor-store owner no longer has money to spend on Internet porn. Given that Internet porn is the only fundamentally sound engine of the American economy, we’re playing with fire here. If that stalwart industry is allowed to fail, Asian p*rn companies will rush to fill the void, offering porn that is both cheaper to produce and way hotter than ours. What will it take to keep this from happening? There are no guarantees, but sending me a check for twenty million dollars would buy us all valuable time.
That all made me wonder: is “too big to fail” just a commitment problem for governments? I don’t think so. The basics of coalitional game theory tell us that those who add the most value get the most rewards. (This is basically the way we teach economics here at MBS). So when you are dealing in the market place, it is, in fact, your goal (if you want to create lots of shareholder value) to make yourself as important or valuable as possible. What that means is that, should you ever consider leaving the game, through choice or impending bankrupcy, so long as that involves taking away what made you valuable others will fork up cash and other stuff to keep you around.
Of course, when a big supplier is able to hold-up its customers with this threat and force costs (including those of mismanagement) on to them, there are no apparent claims of moral hazard etc. But when an important firm holds-up the government the same way, there is some big issue.
Now my point here is not that the issue is not there for government hold-up. Instead, my point is that it is there in the private case too and as people from Oliver Williamson onwards have told us, this is not too efficient a state of affairs.
Interestingly, the solution to such hold-up in the private sphere can often be acquisition. So we shouldn’t be surprised and perhaps should even demand a similar solution in the public sphere. Basically, if we are worried that some firms are too big to fail, that is an argument for nationalisation.