macroresilience

resilience, not stability

A “Systems” Explanation of How Bailouts can Cause Business Cycles

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In a previous post, I quoted Richard Fisher’s views on how bailouts cause business cycles and financial crises: “The system has become slanted not only toward bigness but also high risk…..if the central bank and regulators view any losses to big bank creditors as systemically disruptive, big bank debt will effectively reign on high in the capital structure. Big banks would love leverage even more, making regulatory attempts to mandate lower leverage in boom times all the more difficult…..It is not difficult to see where this dynamic leads—to more pronounced financial cycles and repeated crises.”

Fisher utilises the “incentives” argument but the same argument could also be made via the language of natural selection and Hannan and Freeman did exactly that in their seminal paper that launched the field of Organizational Ecology”. Hannan and Freeman wrote the below in the context of the bailout of Lockheed in 1971 but it is as relevant today as it has ever been: “we must consider what one anonymous reader, caught up in the spirit of our paper, called the anti-eugenic actions of the state in saving firms such as Lockheed from failure. This is a dramatic instance of the way in which large dominant organizations can create linkages with other large and powerful ones so as to reduce selection pressures. If such moves are effective, they alter the pattern of selection. In our view, the selection pressure is bumped up to a higher level. So instead of individual organizations failing, entire networks fail. The general consequence of a large number of linkages of this sort is an increase in the instability of the entire system and therefore we should see boom and bust cycles of organizational outcomes.”

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Written by Ashwin Parameswaran

June 8th, 2010 at 3:45 pm

3 Responses to 'A “Systems” Explanation of How Bailouts can Cause Business Cycles'

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  1. […] A “Systems” Explanation of How Bailouts can Cause Business Cycles […]

    News Roundup

    3 Jul 10 at 3:05 pm

  2. This piece coauthored by the President of the Richmond Fed might interest you: “Now How Large Is the Safety Net?”

    John

    7 Jul 10 at 4:31 pm

  3. John – thanks. an interesting and sobering piece from Jeff Lacker who’s always worth reading.

    admin

    9 Jul 10 at 7:18 am

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