The Instigator
darkkermit
Con (against)
Losing
0 Points
The Contender
bluesteel
Pro (for)
Winning
16 Points

A Corporation can be "too big to fail"

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Voting Style: Open Point System: 7 Point
Started: 10/13/2011 Category: Economics
Updated: 5 years ago Status: Voting Period
Viewed: 1,527 times Debate No: 18781
Debate Rounds (5)
Comments (6)
Votes (4)

 

darkkermit

Con

One of the many criticism of expanding corporation and businesses is that they can become "too big to fail", or in other words, that If a large corporation becomes bankrupt it will create a massive economic catastrophe. I will argue that a corporation cannot become "too big to fail".

The first round will be for clarifications of definitions and introduction. Debating will begin in Round 2.
bluesteel

Pro

Thanks for an interesting topic darkkermit. It is one I (claim to) know a great deal about.

The Glass-Steagall Act, passed during the Great Depression, prevented the merger of commercial banks, investment banks, and insurance companies. There were good reasons for doing so, as I'll explain in the next round. The REPEAL of the Glass-Steagall Act, under the deregulation regime of President Clinton (and due almost entirely to the lobbying of Senator Phil Gramm), allowed the formation of ENORMOUS mega-banks that were "too big to fail." For example, Citibank, Smith Barney, Primerica, and Travelers Insurance all merged together, immediately after Glass-Steagall's repeal, to form a mega-bank, i.e. Citigroup. Citibank was a commercial bank (which keeps deposits); Smith Barney was an investment bank (which creates investment vehicles, like "mortgage backed securities"), and Travelers was an insurance group (which includes offering to insure the financial losses of investment banks). I'll discuss later why combining them is bad, but this is just for background. You'll come to see why Nobel-prize-winning economist Paul Krugman calls Phil Gramm the "father of the financial crisis" (of 2008).

It's obviously important for my purposes that a "corporation" include banks. The fact that Citigroup is listed as "Citigroup Inc.," which means it is "incorporated," or registered with the government as a "corporation," should hopefully suffice.

As the instigator, darkkermit seems to accept the burden of proof, which would mean he has the BURDEN to show that the failure of mega-banks would not have had ripple effects throughout the economy. Remember the following banks received bailouts: Fannie and Freddie, Citigroup, Bank of America, AIG, Wells Fargo, JP Morgan Chase, Morgan Stanley, Goldman Sachs, American Express, Comerica, Capital One, Lincoln Financial, and hundreds of other banks. [1] The failure of ONLY Lehman Brothers, when the government refused to bail them out, touched off said financial crisis. If I do nothing and darkkermit fails to present a scenario in which the simultaneous failures of ALL OF THOSE BANKS does not hurt the economy, I win because he fails to meet the burden of proof.

I await his case with baited breath.

[1] http://projects.propublica.org...
Debate Round No. 1
darkkermit

Con

Wow I did not have access to the internet, and didn't realize how little time I had left once I went to the local library.
There's still 3 rounds available for debating, so do you mind skipping this round? Sorry about that. :p.
bluesteel

Pro

I've been trying to decide whether to be mean and post a full round or to just be nice and post nothing. I've decided to post what I had already typed up PRIOR to darkkermit's forfeit, since it's not my fault he couldn't post his argument.

Here we are:

I'll begin with a very simple argument, and then dive into the nitty-gritty arguments about banking and derivatives [in a later round].

C1) Essential industries

I doubt anyone would really shed a tear if, for example, Microsoft went out of business. People could keep using old versions of Windows, switch to Linux, or wait until another replacement was created to fill the void. However, there are some industries where people cannot survive without that industry's product or cannot switch to an easy substitute; these industries include: food, electricity, and financial services.

So our first observation is that not all industries are the same. Industries where people HAVE to buy the industry's product, for whatever reason, are said to have "inelastic demand." By definition, inelastic demand means "consumers cannot consume (much) less of the product and cannot switch to another, related product." Large corporations in industries with ELASTIC demand may NOT be too big to fail (because consumers can stop consuming or can switch to another product), but large corporations in markets with INELASTIC demand ARE too big to fail.

The second observation we need to make is that the resolution is theoretical: darkkermit needs to prove that a company CANNOT become too big to fail. So I merely need to prove that a company in one of these industries CAN become too big to fail, theoretically, not that any company current IS too big to fail. Let's look to a few quick hypotheticals:

We all know that large agro-businesses have been buying up small family farms for a long time. For the sake of argument, imagine a world in which Monsanto owned 100% of corn and wheat production in the United States. Corn is used to feed all our livestock, so if Monsanto went out of business, there would be mass starvation in the United States, at least until the next planting season started. There is simply no way that tens of thousands of small family farms could quickly fill the void created by an enormous agro-business going bankrupt. Thus, large agro-businesses are "too big to fail."

The above hypothetical is not that far from the truth. The agricultural industry went through two "revolutions" to increase crop yields in recent decades, but these two revolutions ultimately made the industry dependent on a few large seed suppliers. In the 80's and 90's, we underwent the "Green Revolution," where selective breeding of crops led to heartier varieties that grew more quickly with less need for fertilizer. More recently, we underwent the "Gene Revolution," which introduced genetically modified strains of crops in order to even further increase crop yields. Because the best seed varieties are very difficult to produce, farmers all generally buy their seeds from large corporations. According to Forbes, Monsanto has 95% market share in the U.S. seed industry. [1] Since farmers have lost the ability to produce their own seeds, this means that if Monsanto went bankrupt, we wouldn't be able to produce enough seeds quickly enough to feed our country.

In the other hypothetical, just picture the same market domination, but by PG&E in the power industry. If PG&E owned 100% of power plants, then their bankruptcy would bankrupt the entire U.S. economy. All businesses would need to shut down, since every modern business relies on computers, which rely on power.

Financial services, i.e. the ability to borrow and transfer money easily throughout the economy, are equally essential, but are slightly more complicated, which is why I will cover them separately in my later points.

[1] http://tinyurl.com...
Debate Round No. 2
darkkermit

Con

Many thanks to my opponent, bluesteel.

The role of profits:

Profits are a signal that demonstrate that a good or service is demanded by society. For example, people buy food, clothing, and such because these goods and services are desirable. Profits = Revenue - Expenses. If Revenue is too low, then this means that the product is not desired, either because there are too many competetiors or the good or service is simply not demanded based onthe expense it takes to purchase the product.

Opportunity costs and scarcity:

Opportunity costs are opportunities lost due to decisions made. For example, instead of debating, I could have watched television. Resources ar scarce. There is only so much oil, labor, and natural resources. Decisions must be made on where to allocate these resources. So how are these decisions made? Well, in a market economy, these decisions are made by individuals, who either want to maximize their "utility". Producers want to make a profit since money has value. Consumers want to purchase projcts that they find valuable. Material can be used either to give the consumer value, or to make goods or services (capital goods and natural resources). The cost of goods and services reflect the supply and demand for them. A purchaser sells the good or service, since he or she gains utility, in the form of payment, from the action. A consumer buys the good or service, since he or she gets subjective value from the product. One person consuming a resource means that another cannot. So If a company is using resources without making a profit, then waste occurs, since these resources could have been used in other sources. Furthermore, these goods and services do not improve the utility of the produer, since he or she only values them for their ability to make money, however theses goods and services clearly are not.


An unprofitable corportion is misallocating resources, bankuptucy reallocates these resources to either consumers or more profitable organizations:

As demonstrated above, an unprofitable corporation is simply consuming all these resources without creating value to anybody else. The company is aking away opportunities to other companies that could use these resources instead. Therefore the ideal solution is for the compnay to go bankrupt. Bankrputucy does not mean that the resources the company made are gone, but mearly means that they are reallocated to companies and individuals that can make better use of them, or manage the resources better. Such a system is known as "creative desturction". Through the destruction of some companies and individuals, new opportunies are built for others. These forms of "creative destruction" are necessary to improve economic growth and increase the standard of living. Where would we be If the carriage industry was bailed out, since they could not compete with automobiles? Or what If the telgram industry was bailed out, due to the competition of the phone industry? Society could not have advanced as much a it had. Blockbuster is a modern day example that is unprofitable since people demand the cheapter alternative of Netflix and RedBox. Netflix and RedBox employee many people, the cheaper alternatives give consumers more purchasing power to buy other goods and services, and the removal of Blockbuster allowed its resources to be allocated to other businesses (Ex: businesses could not purchase rental space that Blockbuster used up).

Rebuttal:

My opponent makes claims that it would be a disaster If goods and service with an inelastic demand were suddenly removed from the market. However this makes too assumptin. First, it assumes that the resources that a corporation had were simply destroyed If it became bankrupt, it simply means that the resources are shifted to a new company or other individuals. It also begs the question of If these goods and services are in such demand, then why is the corporation going bankrupt? Products that are not in demand, are simply not produced. Products that are demanded, are produced. This is the system of the free market.This is the importance of profits, it signals which goods and services are most needed in society. Bailing out losers simply distorts these price signals and create perverse incentives, and do not allow the creative destruction process to occur which will create new goods and services in the market that are more desirable and/or allow better managment of these resources that were previously misallocated.

Thank you and I look forward to your response.
bluesteel

Pro

Thanks for the response darkkermit.

==Rebuttal==

My opponent cites a number of economic concepts but none of them prove that a corporation cannot become "too big to fail."

R1) The Role of Profits

All of my opponent's arguments here assume a) multiple firms in a competitive market and b) relatively elastic demand. Darkkermit himself says that a lack of profits means either a) too many competitor firms or b) a lack of demand (which is not possible if demand is inelastic). However, all of my arguments deal with industries that have a) very few firms and b) inelastic demand, meaning an inability of consumers to consume less or to switch to other products. So darkkermit's arguments don't apply.

R2) Opportunity cost and scarcity

Darkkermit argues here that a firm that is "unprofitable" is wasting resources. This is true. A firm that CONSISTENTLY (each business Quarter) fails to turn a profit IS wasting resources. However, firms go bankrupt for reasons OTHER than failing to consistently turn a profit. Often times, although a firm consistently turns a profit each quarter, the firm takes a huge, temporary loss that it cannot cover. After a bailout to cover the firm's losses, the firm is more than able to return to turning a consistent profit. If anything, letting the firm go bankrupt is wasteful because it is still a potentially profitable firm. I'll offer two examples: 1) if there was a temporary one-year drought, Monsanto might be in danger of going out of business, but could survive if the government covered its temporary losses; 2) Goldman Sachs lost too much money in the 2008 Financial Crisis, but was able to return the government's bailout money after only a few months and return to profitability.

I'll agree with darkkermit that the government should not bail out firms in markets where each firm is small and there are a large number of competitor firms. I'll also agree that the government should not bail out firms in markets where demand is relatively elastic. I only argue that businesses in essential industries (food, power, and financial services) can become too big to fail.

R3) Bankruptcy reallocates resources

Economists are always stressing the difference between the LONG RUN and the SHORT RUN. Creative destruction occurs in the LONG RUN. Eventually, if a large monopoly goes bankrupt, smaller and more efficient firms will move in to take its place. However, in the short run, the bankruptcy of a large monopoly causes what we call a "supply shock," which is a huge disruption in supply that causes a massive spike in prices. The problem is, as I argue, that in essential industries with inelastic demand, the short run supply shock that occurs for the first 5-15 years causes too much damage before the long run benefits start materializing (after 15-40 years). If the economy cannot survive the short run shock, then the long run benefits don't matter.

Also, when a company goes bankrupt, it means there is an inefficiency in the MARKET, not necessarily the firm, and we may not like the way the market reallocates resources. For example, in the food industry, the market may decide that there are too many mouths to feed, and we cannot do it without a monopoly, so the market's solution to this problem will be smaller farms and mass starvation. The market may decide to eliminate demand, rather than shifting supply elsewhere.

My opponent discusses bankruptcies in the "carriage industry," "telegram industry," and "Blockbuster," but none of these is in an essential industry with inelastic demand. By definition, because there are plenty of alternatives in these cases, demand is ELASTIC, meaning consumers can easily switch to a related product. I would agree that we should let the firms darkkermit cites go bankrupt.

R4) Response to darkkermit's rebuttal

Darkkermit says I assume that when a company goes bankrupt, its resources do not magically shift to other companies. This seems to be a reasonable assumption, and darkkermit is clearly misunderstanding what his sources mean by "reallocating resources." If an oil company goes bankrupt, the market allows another oil company to seek out oil instead. But it's not like everything that the bankrupt firm had suddenly goes to other companies. If Monsanto went bankrupt, no other company could suddenly swoop in and produce millions of seeds, even if Monsanto's factories were all put up for sale; it takes A LONG TIME to rebuild Monsanto's expertise and rehire or retrain thousands of employees, and it takes too much capital to buy every single factory. In fact, because of patents, no one would EVER be able to reproduce Monsanto seeds. In the LONG RUN, Monsanto will be replaced, but in the SHORT RUN, no one will be able to QUICKLY reproduce its seed production capacity. So we run out of food in the short run.

Or a better example of how resources are NOT conserved when a firm goes bankrupt is: a run on a bank. Commercial banks take deposits from people and then make loans using that money. So these banks do not have enough cash in their vaults to pay every depositor if they all come calling at the same time; the banks need the debtors to pay them back before they can return all the deposits. Typically, banks only keep enough cash on-hand to cover 10% of their liabilities (money owed to other people). A "run on the bank" occurs when a crisis - such as the financial crisis prior to the Great Depression – causes people to panic and demand their money all at once. After the bank pays the first 10% of people, it runs out of money and declares bankruptcy. The remaining depositors all lose their money!! How are resources "reallocated" in this case, as darkkermit suggests? When a bank goes bankrupt, wealth is permanently destroyed; it is NOT conserved.

==My case==

Let's begin with the dropped arguments.

1) Burden of proof

Remember, the following banks received bailouts: Fannie and Freddie, Citigroup, Bank of America, AIG, Wells Fargo, JP Morgan Chase, Morgan Stanley, Goldman Sachs, American Express, Comerica, Capital One, Lincoln Financial. Darkkermit fails to explain how the simultaneous failure of all these banks would not have hurt the economy.

2) Monsanto and PG&E

Darkkermit doesn't respond to these two examples of companies in essential industries. He fails to explain how the economy can weather a lack of food and power. His only potential response is creative destruction, but this only occurs in the long run. The economy can hardly survive without food and power for 5-10 years or more. So if a monopoly in the food or power industry went bankrupt, we'd be really screwed.

Even if some smaller firms could start producing food or power, they would not produce anywhere near ENOUGH to replace the monopoly. The result will be a supply shock, which means a massive increase in prices. Only the rich would be able to afford food or power.

Consider the following example: OPEC's oil embargo of 1973. OPEC is a cartel but it can be treated, for our purposes, as an oil monopoly (at least it was a true monopoly in 1973). When it severely restricted supply in 1973, this had a DRASTIC effect, but a LESSER effect than if OPEC had gone bankrupt and ceased to exist. If darkkermit is right, the contraction in OPEC supply SHOULD HAVE led to other firms taking over oil production. But it did not, at least in the short run. If OPEC had gone bankrupt, rather than restricting supply by 50%, it would have restricted supply by nearly 100%. There is no reason to believe, given our inability to replace 50% of our supply with other suppliers, that we would have been able to replace 100% of our supply. According to a study by NYU, the 1973 oil price shocks destroyed 1.2% of disposable income in the U.S., which is approximately $100 billion. [1] [2] The shock would have been much worse had OPEC not ended the embargo after only 6 months or had they cut off ALL supply. If we cannot replace an oil monopoly in the short run, there is no reason to believe we could replace a food monopoly or a power monopoly either.

New argument:

3) How banks became too big to fail

The following is borrowed heavily from Charles Morris' "The Two Trillion Dollar Meltdown."

With the repeal of the Glass-Steagall Act, commercial banks, investment banks, and insurance companies started combining into enormous mega-banks. This was a big problem.

Commercial banks and insurance companies had suddenly taken on the risks of the investment banks, by combining with them. Investment banks had always made risky investments, like investing in mortgage-backed securities, but before the repeal of Glass-Steagall, an investment bank that made bad investments would merely go bankrupt. If it insured its losses with an insurance company, its investors would still get their money back. However, by combining with insurance companies, investment banks ensured that if they bankrupt their parent company, the insurance arm of said company would have no money left to cover financial losses. Secondly, by combining with commercial banks, investment banks ensured that they were wagering OUR savings accounts into extremely risky ventures, like mortgage-backed securities. So if the mega-bank went bankrupt, we would lose our savings accounts as well. This FORCED the federal government to bail out the banks because they would have had to pay either way; it was either a bailout OR FDIC (federal deposit insurance, up to $100,000) would have to cover the loss of every savings account in the country.

When the banks were separate, the failure of risky investments would only bankrupt the small investment banks. Combined, however, risky investments spread the risk throughout the ENTIRE financial system. Add to that the concept of leverage, and the situation is even more troublesome. Using leverage, investment banks allow investors (and themselves) to use $1 to make an investment of more than $1. Consider an anology: if a casino let you do this, here is the way it would work. You would go to the Roulette table with ONLY $1 in your pocket. The casino would let you place a bet of $30 on black (a leverage ratio of 30-to-1) using only your one dollar bill. If you won, the casino would give you $31 (your $30 in winnings plus your original $1), but would keep the $29 of their money you used to make the bet. If you LOST, you'd owe the casino $29 dollars. That's how leverage works.

Prior to the financial crisis, Bear Stearns was leveraged at a ratio of 33-to-1. At this ratio, a 3% loss wipes out the entire company. These kind of risky bets are fine when the investment bank is just betting its own money, but it is NOT fine when it is also betting people's insurance policies and their savings accounts.

Credit default swaps were a way for banks to INSURE their risky investments (mortgage-backed securities). A mortgage-backed security is essentially a bundle of individual mortgages that an investor can buy. Investment banks, at this time, demanded high rates of return and by definition, more risk leads to greater returns, so banks would cut out the safer mortgages, and started only bundling the risky mortgages (subprime mortgages) together. They KNEW these investments were risky, so insurance companies started issuing a credit default swap, which means that if you lost money on the mortgage-bundles (securities), the insurance company would pay back the losses. The reason that when Lehman Brother's failed, this touched off the financial crisis, was because Lehman Brother's had been issuing credit default swaps to investment banks. When banks realized that their financial losses from the mortgage crisis were no longer insured, chaos ensued.

So here's the chain of events:

(1) The mortgage market goes sour. (2) Mortgage-backed securities take huge losses. (3) Investment banks are leveraged at high ratios of around 30:1. (4) This means that a 3-4% loss in the market for mortgage-backed securities will bankrupt the PARENT company. (5) Parent companies went bankrupt, meaning they ran out of money. (6) Parent companies, because of the repeal of Glass-Steagall, also included commercial banks and insurance companies. (7) Since the insurance companies were now bankrupt too, they couldn't cover the financial losses they were supposed to cover. (8) Since the commercial banks went bankrupt too, our savings and checking accounts were gone too. (9) The government had no choice but to bail out the banks.

If Glass-Steagall hadn't been repealed:

(1) Investment banks lose money. (2) Insurance companies, being separate, still have capital to cover the losses. (3) Our savings accounts are safe in a completely separate bank.

And that's the story of how the repeal of the Glass-Steagall Act caused banks to become too big to fail.

Vote Pro.

[1] http://people.stern.nyu.edu...

[2] http://www.euromonitor.com...
Debate Round No. 3
darkkermit

Con

darkkermit forfeited this round.
bluesteel

Pro

okely dokely...
Debate Round No. 4
darkkermit

Con

Sorry for wasting PROs time, but since I already forfeited 2 rounds, PRO is the winner.
bluesteel

Pro

Thanks darkkermit.
Debate Round No. 5
6 comments have been posted on this debate. Showing 1 through 6 records.
Posted by bluesteel 5 years ago
bluesteel
thanks! you too
Posted by darkkermit 5 years ago
darkkermit
Well there goes my winning streak :p. Good luck bluesteel.
Posted by BlackVoid 5 years ago
BlackVoid
Oh nvm, you said it first.
Posted by BlackVoid 5 years ago
BlackVoid
I think he's implicitly referring to bailouts.
Posted by darkkermit 5 years ago
darkkermit
That's why I started the challenge. It's in the economics section, "Why hate corporations?. The context is the latter. Basically, that a large corporation will become so large that If it fails it will cause economic problems. So government needs to bail it out to stop it from failing.
Posted by F-16_Fighting_Falcon 5 years ago
F-16_Fighting_Falcon
Someone made that claim in the forums? Where? I want to see it in context because I don't understand the resolution.

Do you mean to say that it is impossible for them to fail or just that failure will have too big an effect on society?
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Vote Placed by Multi_Pyrocytophage 4 years ago
Multi_Pyrocytophage
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Vote Placed by Travniki 4 years ago
Travniki
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Vote Placed by 16kadams 5 years ago
16kadams
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Vote Placed by cameronl35 5 years ago
cameronl35
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Reasons for voting decision: Forfeit from Con