Crisis Indicators: Organizational Size

Much of the Senate's investigation into the role investment banks had in causing The Great Recession is to understand why they were short on their long positions.

Why, for example, did financial firms not simply sell their long positions rather than buy CDO's on the RMBS's to reduce the risk?

Either way, selling long or short, indicates a high level of risk, but shorting the economy--providing a disconnect, a timing differential, between the risk and the realization of that risk--locks in a larger profit than the zero-sum on the long position alone. The large short position is not to just simply hedge the risk, but to cause it.

Large investment banks, then, deliberately caused economic crisis to benefit from timing the trend by causing it.

It is an illegal manipulation of markets (rigging the market) to effect an equally illegitimate gain in zero-sum. The big short transactions incurred a very high risk of liability (a conflict of interest) that the banks consider an economy-of-scale efficiency that facilitates economic growth by "making markets."

A firm that goes long gives support, going short gives resistance. Going both long and short, especially operating with capital on an economy of scale, manipulates the market to fit the determined level of proprietary risk--none! The "free market" is effectively not operational and all that is left is the gamma risk.

Senator Levin, Subcommittee Chairman on Governmental Ivestigations, examining the specific case of Goldman Sachs, is incorrect to say that the financial crisis was not the result of "big size, but the big short."

Long or short, it is the size of the firms and their economy-of-scale transactions that give them the power, the reward, of systemic risk with limited or no liability. Organizational size is the source of the big profits (without growth). It provides the magnifier effect that commands trends and their sudden reversal in the exculpatory guise of undirected, cyclical trending. Since that trending is falsely attributed to the dynamics of free-market economics, and thus the need to hedge the risk of fluctuation, there is always the opportunity to cause the direction of the trend (the risk) with a very limited liability, if you are big enough.

Firms like Goldman Sachs defend their conduct as playing the game of freedom according to the rules of the game. Freedom reduces to the utility of pursuing one's self-interest. No one should be surprised, and it is no crime, to win the game in zero-sum. In fact, it is the moral good because it is the strength, the motive, to expand the pie and provide for the general welfare.

Firms like Goldman Sachs are not providing capital, they are accumulating it to a detriment. That detriment not only empirically indicates a measure of liability, but the probability of crisis. If allowed to continue doing business with a model of organized consolidation, which includes a collusively complex counterparty interdependence, the detriment and the risk of liquidity crisis is conserved, not reduced.

Being able to manipulate on a scale that causes systemic risk (and the huge profits we see big banks reaping from it) is a function of organizational size, not how ethical they are. As far as they are concerned, making as much as you can as quick as you can is the right thing to do.

In a free and unconsolidated marketplace, the level of ethical intelligence is sufficient but not necessary. People are not likely to do business with firms that cannot be trusted, unless they have to.

A genuine free market does not rely on an abstract moral intelligence, but a practical intelligence in a systematic environment that "demands" trustworthiness to survive the market in one's self-interest.

A free market freely forgives transgression, maintaining productivity in the fullest capacity. Rather than doing dirty deeds, being grilled before a congressional committee, going home and doing it all over again the next day, the transgressor learns how to survive the marketplace and contributes the desire for profit and power in the form of productive capacity (the alpha-risk distribution of power and profit).

Deconsolidation operationalizes the reduction of freedom to an ethical utility of seeking power and profit into a systemic benefit rather than a constant risk of detriment and deprivation (liquidity crises).

Deconsolidation will cause economic growth quickly and efficiently in pursuit of self-interest. It will be guided by the strength, the virtue, ensured by a high level of alpha-risk distribution rather than insured by the securitized bundling (consolidation) of risk that clearly indicates crisis.

Large banks and investment firms argue, however, that deconsolidation will put America's financial sector at a competitive disadvantage worldwide. Deconsolidation as a measure of financial reform, big banks argue, will inhibit America's ability to grow in a global economy.

Being globally competitive, they argue, requires firms with a large, economy-of-scale efficiency to command the capital necessary for large capital projects.

The argument for consolidation to achieve a competitive advantage is false both nationally and internationally.

Consolidation does not increase competition by reducing risk, it reduces competition and increases systemic risk.

Deconsolidation will increase competition and reduce risk, giving a competitively trustworthy advantage to America's capital markets. Others will follow to gain that advantage as well.